INFLATION concerns eased last week and there were implications for central bank messaging.
There had been concern that higher inflation would prompt central banks to shift messaging more aggressively towards potential rate hikes.
That seems to be allayed for now.
This came via statements from central banks, a US labour report that indicated a return of supply, and the firming chances of Jay Powell being appointed for a second term at the Fed.
Bond yields fell in response. In combination with a decent US earnings season and good news on Pfizer’s antiviral pill, the S&P 500 rose 2.03% and the S&P/ASX 300 gained 1.91%.
US equities have had a strong run, up 9.17% for the quarter to date.
Australian equities have lagged, up only 2.02%. This reflects our skew to resources and the need to digest new capital issuance.
While they might pause for breath in the near term, equity markets should remain sell-supported into the year’s end.
Various statements from central banks went a long way to calming the market’s concerns about how quickly rates will need to rise.
The Fed announced it would begin tapering asset purchases by US$15 billion per month, implying that Quantitative easing would end in mid-June 2022.
This is in-line with expectations and was a dovish statement given speculation that the rate might have been accelerated.
Chair Powell was at pains to talk down inflationary fears. He noted that “transitory” did not necessarily mean “short-lived” — rather they were not expecting “permanently higher inflation”, ie a wage-price spiral. They did give themselves room to adjust their plans.
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A strong showing for the Republicans in gubernatorial elections in Virginia and New Jersey is seen as beneficial for Powell’s chances of securing a second term as Fed Chair.
The view is that the Biden Administration will not want to appoint a potentially less-predictable candidate to the Fed at this point.
The Bank of England caught the market on the hop when it kept rates stable. A 15bp rise had been signalled and widely expected. The BoE pushed back against the market projection for rate increases — citing signs of slowing economic momentum — and made the case for transitory inflation.
The market is still pricing in a 15bp move for December and is split as to whether the following one will be February or May.
So at this point major central banks are signalling a lagged response to rising inflationary pressure.
This also flowed through into a lower trajectory for projected ECB rate rises.
The RBA also adjusted its messaging.
The three-year yield target was removed as expected. The possibility of a rate rise in 2023 was also mentioned for the first time.
The Reserve noted that the labour market was stronger than expected, but border re-opening should provide additional supply.
This remains to be seen.
The market is still wary of inflationary pressures, particularly in housing. Nevertheless, there was relief that the RBA didn’t take a dogmatic stance towards the target for a first hike in 2024.
The dominant narrative at this point is that global growth is accelerating following a hit from the Delta strain and disrupted supply chains.
Bottlenecks persist but there are signs the situation is improving.
This was reinforced by US payroll data, which showed 531,000 jobs were added in October, versus 450,000 expected.
The previous month was also revised upwards by 235,000 new jobs. The private sector added 604,000 new jobs, which was good, while the government sector shed 73,000 jobs.
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The underemployment rate fell from 4.8% to 4.6%. Wages grow rose 0.4% to 4.9% year-on-year.
The household survey showed the labour force rose 104,000 after falling 183,000 in September.
However the participation rate remain a key variable in the outlook for wage inflation. It was 63% pre-pandemic, fell to 60% during the economic downturn and is now steady at 61.6%.
The St Louis Federal Reserve estimates there have been more than 3 million retirements in excess of what would normally be expected. This represents more than half the 5 million people who left the workforce since the beginning of the pandemic.
The resulting tight labour market can be seen in the ratio of employed workers to each new job opening, which is at its lowest point since measurement began in 2001.
So the outlook for inflation and bond yields — and the effect on growth stock premiums in the equity market — will be very tied to wage growth in the US.
This continues to move higher and is probably the key macro factor to watch in the coming year.
That said, it is worth noting that given the high rates of inflation, current real wage growth is negative.
This helps explain a backlash against the Democrats last week and a rising incidence of industrial action in the US.
New daily cases in the US continue to flatten.
One factor to watch here will be the combination of waning immunity from vaccines and the onset of colder weather. We are seeing the number of people getting a third jab picking up quickly.
We are also watching the situation in China, which is going it alone in pursuit of zero-Covid. This could see an impact on economic growth — and potential demand for commodities.
The more important news was that Pfizer published data on its anti-viral pill, which so far in trials is indicating an 85% reduction in severe cases.
The US equity market may be a touch over-bought in the near term. But there are positive signals for the outlook into the year’s end:
In the US, 89% of companies have reported quarterly earnings.
Market eps is up 38% year-on-year. While a deceleration from previous quarters, this is well ahead of the +27% consensus expectation.
About 60% of companies have beaten expectations by a standard deviation or more, versus a long-term average of 49%.
Given the headwinds of supply chain and Delta this is a very good outcome.
The S&P/ASX 300 did well last week despite a drag from resources, which is the now the worst-performing area for the year to date.
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
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