US payroll data last week indicated that wage pressure is perhaps easing faster than expected.
If this comes without the need for a substantial rise in unemployment, it potentially allows the Fed to pause sooner than expected.
While it is dangerous to extrapolate one month’s data, it did drive bond yields lower while equities and gold moved higher.
The S&P 500 rose 1.5% and the S&P/ASX 300 gained 1.1%.
China’s shift away from their covid-zero policy continues to accelerate faster than almost all expectations. There are signs that Beijing has seen the worst of its wave, with a number of other cities close behind.
This suggests there will be more travel in Chinese New Year and a faster recovery once we get through February.
Iron ore rose a further 16.5% in response. Industrial metals also began to show some life.
Oil bucked the trend of commodity strength. Warm weather in the US and Europe – with forecasts of more to come over the next two weeks – drove gas prices lower, which flowed through to oil.
This helps with the narrative of easing inflation and less pressure on growth, although it is a short-term factor.
There are six key questions leading into 2023.
Initial signs on the first three issues are positive. The first datapoints of the year suggest that inflation is lower than consensus expectations, which in turns requires less tightening, a milder downturn and a small hit to earnings.
This supports markets in the near term. So too does the current outlook for China.
The consensus view has been for markets to re-test equity low points in the first quarter as earnings revisions turn negative.
As a result investor positioning has been cautious, with the market braced for a poor reporting season. Ironically, this may lead to the market holding up better than expected.
Near term liquidity may also be supportive. The US Treasury has been running down its cash position as it nears its debt ceiling.
In the near term, this offsets some of the effect of quantitative tightening. That said, it is hard to see a sustained market move materially higher.
The Fed is likely to rein in any substantially easing of total financial conditions – which includes equity markets. The economic downturn is still also likely, with earnings set to fall. A market multiple of 17x in the US does not provide much of a buffer to this.
US December payroll data showed a clear slowdown in Average Hourly Earnings. December’s print of 0.3% month-on-month growth was below the 0.4% consensus expectation.
November’s 0.55% figure was also revised down to 0.4%. This was an unusually large revision – a 3.5 standard deviation event and the largest since 2011.
Three month annualised wage growth now stands at 4.2% and annual growth at 4.6%.
The longer-term deceleration is now evident. The Fed will still want to see these figures below 4%, but it is likely to lock in a 25bp rate hike in February unless we see a dramatic deterioration in CPI numbers this week.
It is worth noting that other wage measures such as the NFIB survey are not as positive yet. Given the scale of swings in revisions, some caution should be applied to the Average Hourly Earnings data.
The other key message from the payroll data is that while employment growth is slowing, it remains resilient. December payrolls rose 223k in December, above consensus expectations of 203k. This is still too high for the Fed to feel comfortable about inflation.
We note that the annual benchmark process takes place in February. This can lead to significant revisions.
Last’s month’s discrepancy between payroll data and the household survey unwound this month. The latter rose 717k, with unemployment falling back to cycle lows of 3.5%. The argument that this signalled overstated job growth is now dispelled.
There was a second consecutive monthly fall in hours worked, which is a signal that the economy is slowing.
There is a reasonable argument that companies may “hoard” labour this cycle and reduce hours worked rather than lay off employees, given the recent challenges in hiring and high turnover rates.
Labour force participation rose this month and the additional supply may also help constrain wage growth.
Overall, the data suggests reduced risk of recession as we have seen wage growth decelerate without a rise yet in unemployment. Hence the market’s positive response.
All eyes will be on the CPI print on the 12th. Forward indicators are suggesting inflation easing off further.
Beijing’s policy U-turn is remarkable.
The Golden Week holiday runs from 21st to 27th of January this year. By that stage it appears that many people in major cities will already have had Covid. The travel during this period is likely to exacerbate the wave in other regions.
The true reasoning behind the change in policy is opaque. But it does appear as though Beijing has made a calculated gamble to wear the disruption this causes at what is traditionally a very quiet time of the year for the productive side of the economy.
While official Covid stats don’t provide much insight, other source such as commuting data (eg subway use) suggests that the slump in activity may already have bottomed, particularly in the major cities.
The shift in the target for bond yields has led to a sharp move higher in Japanese government bonds and is putting pressure on the Bank of Japan to intervene in the market.
One potential knock-on effect is possible repatriation from other bond markets as a result of the higher yields and stronger Yen.
Japanese holdings of US bonds have moved negative year on year. Other bond markets such as Australia are potentially more vulnerable to such selling, which may lead to bond yields holding at higher levels.
Over the next two weeks the US is forecasting temperatures 2.4 stand deviations above normal and Europe 2.1 standard deviations.
Austria’s ski slopes in January don’t normally resemble Thredbo in October. It goes some way to explain the recent weakness in oil prices.
The unseasonably warm weather helps Europe avoid the near-term energy crisis many feared. It has meant gas prices down -16% for the week, which has fed through to lower oil and electricity prices.
It is also raining hard in California, which will help with hydro generation.
All up it is estimated the weather effects are causing oil demand to be 1.4m barrels per day lower than normal. With China still in the midst of a covid wave, demand there has not yet started to pick up. That said, these are temporary factors and a reversion back to normal temperatures and China re-opening should help oil demand recover within a month.
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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