Where Are We Headed?
This weekly is on the early side and I am wary of what Friday brings, especially as the debt ceiling saga gives rise to further bond market volatility.
In this week’s update – Central Bank action was exactly as expected, last month’s US jobs report was excellent as unemployment fell, and global service activity data was also positive. These were the big highlights of the week as there was nothing to be disappointed about.
The actual rate hikes were exactly as expected – it was the wording around future guidance that mattered and, on this, Central Bankers are expressing optimism that inflation is turning and that rate hikes are reaching the end. Powell said at least a "couple" more increases will be needed to cool inflation sufficiently as it still remains “elevated”. His remark that the "disinflation process has started" gave Treasuries a boost - even though he noted it's in the early stages and needs to spread. Fed Funds futures are pricing an 85% chance of a 0.25% hike in March, with 15% saying no change. Markets see a 30% chance of a 0.25% hike in May. The yield curve continues to invert, with the 2s-10s spread at -0.71%. The ECB “intends” to raise rates 0.50% on 16th March and after that it will evaluate based on data. The latest inflation fall is energy (transitory) driven while the core rate has trended higher. Lagarde said the risks to GDP and inflation are more balanced – unlike before when she said it was tilted against GDP. Market pricing suggests another 1.00% tightening by June (0.50% in March and 0.50% in June). The BoE’s forward guidance changed from further hikes “might be required” (last time) to further tightening in monetary policy may only be forthcoming if “there were to be evidence of more persistent pressures”. Their latest inflation projections did not support the case for more tightening with inflation estimated to be at 2% over 2 years and to 1% in 3 years from now. They still kept the door open to rate hikes arguing the risk to inflation is skewed “significantly to the upside” due to domestic wage and price setting pressures. Another reason for upside risk to inflation comes from less pessimistic GDP outlook (vs November). While markets scale back on rate hike expectations, they price in a +0.35% by mid-year and an 80% chance of a +0.25% in March’s meeting. Overall, the tone – while remaining guarded – has changed to a more cautiously upbeat note.
There are no two ways about it, the US January jobs report was simply stellar! +517,000 new jobs (market expectation: 187,000) were created. December 2022 was revised up +37,000 while and November 2022 was revised up +34,000. The unemployment rate fell to 3.4% (lowest since May 1969). Leisure & Hospitality added 128,000, Professional & Business 82,000, Government 74,000, Health Care 58,000, Retail 30,000, Construction 25,000, Transportation & Warehousing 23,000, Social Assistance 21,000 and Manufacturing 19,000. Average hourly earnings rose +0.3% m/m to 4.4% y/y. The Labour force participation rate ticked up +0.1% to 62.4%. Taken together with Thursday’s weekly jobless numbers which continue to improve, this really puts the Fed in a dilemma. This report heightens Fed rate hike expectations to over 5%. The US$ jumped +0.50%.
Service Sector Activity: Good numbers as services start to move above 50 (i.e. expansion) and there was a common theme underlying these numbers: a rise in the new orders sub-indices helped by the lifting of China’s covid regulations, a rise in demand and better than expected growth. Even GDP numbers are being revised upwards (e.g. GS forecasts of China’s Q4 GDP annualised rate)
Finally, what about Commodities? BP recently released its 2023 energy outlook in which it argues oil demand will plateau – even decrease in the years ahead. Well that maybe – the transition to Alternative Energies (AEs) is ramping up everywhere. For example, in 2022, Europe derived 22% of its energy needs via Wind and Solar. It will no doubt expedite that even further this year. Taking into account the clearly improving economic situation (see above), the likelihood is oil demand will pick up this year. In BP’s report, its oil demand scenarios do not include data from 2020-2022 and they don’t start until 2025 from whence it sees lower oil demand vs 2019. Its report sees lower oil demand from transportation as EVs are adopted. If consumption continues to rise, this will put demands on oil consumption. The IEA had forecast an additional average 2m bpd of oil this year. There is scope for the energy price spectrum to rise from here – it is unlikely to balloon unless we are hit with another geopolitical event.
Source: Bloomberg, CNBC, Reuters, Trading Economics and Goldman Sachs.