THE question of when and where US rates will peak remains uncertain. There were no clear, new signals in the past week.
US economic data was mixed.
Housing, manufacturing and producer-purchasing index (PPI) prints were all weaker. Retail sales were stronger than expected.
The head of one of the 12 US federal reserve bank districts did his best to dampen positive sentiment. St Louis Fed President Jim Bullard noted the importance of avoiding the policy mistakes of the 1970s, when rates were dialled back too quickly.
(Bullard soon changes from a voting to non-voting member of the Federal Open Market Committee, the Fed’s chief monetary policy body).
The US yield curve inverted further and commodities were mixed. There were no further signals from Beijing after positive moves on Covid-zero and the property sector last week.
Equity markets held on to most of the gains from the previous week. The S&P 500 fell 0.6% and the S&P/ASX 300 gained 0.13%.
In the US we are seeing more caution creep into management statements around current conditions and the outlook.
This is a necessity — and ultimately a positive — since it indicates tighter rates are slowing the economy.
Bullard made the case that rates need to be between 5% and 7% to slow inflation.
His dovish outlook is for a 5% to 5.25% rate.
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He expects rates to be kept high for an extended period, to avoid the monetary policy mistakes of the 1970s when rates were eased too early and inflation came roaring back.
“We’re going to have to see very tangible evidence that inflation’s coming down meaningfully toward target,” he said. “I think we’re going to want to err on the side of staying higher for longer in order to get that to happen”.
Producer Price Index
The producer price index — a measure of US inflation at the wholesale level — rose 0.2% in October versus 0.4% expected.
This was the smallest increase since July 2021. It’s now running at 8% year-on-year, well below March’s peak of 11.7%.
Core PPI (ex-food and energy) fell 0.1%. It’s now 5.4% year-on-year versus the 9.7% peak in March.
This reflects a broad-based slowdown in goods prices.
Evidence continues to build that corporate margins are coming under pressure as supply chains loosen and consumer spending shifts from goods to services.
The Fed continues to watch corporate margins closely as a lead indicator for inflationary pressure.
The Philadelphia Fed manufacturing index declined by 11 points to -19.4 in November, against consensus expectations for an increase.
It now stands at the lowest level since May 2020.
The underlying composition was weak as new orders, shipments, and employment components all declined.
The US housing market remains dire. New housing starts fell 4.2% and are now down 21% from the April peak. Building permits fell 2.4% in October. (Both results were slightly better than expected, however).
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A key measure of US homebuilder activity and sentiment — the National Association of Home Builders index — plunged from 38 to 33 in November. This was below a consensus of 36.
Sales of existing homes fell 5.9% in October. This was above consensus, but it’s now down about 32% from the January peak.
The supply of new homes in the last data for September stood at 9.2 months of sales.
Mortgage rates have now peaked so demand is unlikely to fall much further. But it will remain extremely depressed for some time yet.
The fall in new housing starts is concentrated in single-family dwellings. Multi-family starts have remained steady for much of the year, but leading indicators such as building permits suggest a small decline in coming months.
Volume activity has been very weak.
The question now becomes: how much do house prices fall from here?
Retail sales data stands in stark contrast to the data points above which support the notion of a cooling economy.
October retail sales rose 1.3% versus 1% expected. Sales (excluding autos) were 1.3%, versus consensus of +0.4%.
It seems clear that consumers are happy to run down the strong savings buffer accumulated during Covid.
This buffer has declined, but still remains in positive territory versus pre-Covid.
Consumption remains on course for a strong end to the year.
One potentially positive sign is retailers offering greater discounts to support sales.
For example, in October Amazon held its second “Prime Day” sale for 2022. These usually only happen once a year.
US retail chain Target noted they would need further markdowns to shift excess inventory by the end of the Christmas period if recent trends persisted.
The EVRISI Retailers survey suggests retail pricing power has collapsed back to pre-Covid levels. This is another requirement for bringing inflation to heel.
The labour market remains resilient with the unemployment rate falling to 3.4%. Unemployment and under-utilisation rates are at a 40-year low.
Employment grew 32,000 in October versus 15,000 expected. The participation rate held steady at 66.5%.
The gains were made in full-time employment (+32,000) while part-time jobs fell 15,000.
Hours worked rose 2.3% for the month, driven mainly by fewer workers taking sick and annual leave.
NSW job growth remains strong, while we are seeing weakening labour conditions in Western Australia.
Tasmania and South Australia are on an uptrend. Queensland and Victoria have flat-lined.
Hourly wage rates (ex-bonuses) in Australia rose +1% q/q and +3.1% y/y in Q3. This was stronger than consensus, which was looking for a 0.9% q/q outcome.
Headline wages growth was the strongest in quarterly terms since Q1 2012.
Quarterly growth in private-sector wages (+1.22% q/q) was the strongest since Q2 2008 (+1.24% q/q) and the second strongest since the WPI series began in 1997.
Private-sector wage rates (includingbonuses and commissions) rose 4.1% y/y.
All this is consistent with feedback from private-sector companies, which are flagging wage growth expectations in the mid-to-high 3% range.
This is a critical factor to watch given the more dovish tack taken by the RBA compared to other central banks.
Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.
Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.
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