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Khatija Haque - Head of Research & Chief Economist
Published Date: 05 September 2023
August has been something of damp squib in terms of equity market performance, with the spring and early summer rally fizzling out last month. Central bank rhetoric has remained hawkish in recent weeks even as inflation appears to have peaked in developed markets, with policy makers pushing back against market expectations for rate cuts sooner rather than later, and this has likely weighed on sentiment towards risk assets.
In his speech at the annual gathering of central bankers at Jackson Hole in late August, Fed chair Jerome Powell stressed that the Fed remains committed to its 2% inflation target, and that inflation “remains too high” even as recent data has been encouraging.
Economic data for the US remains robust, particularly against the backdrop of the sharp rise in interest rates since March 2022, with Powell noting in his comments that the “economy may not be cooling as expected”. While we continue to see weakness in the manufacturing sector, and investment has cooled, GDP growth has remained above 2% this year, supported by strong consumer spending which in turn has been underpinned by low unemployment and rising wages.
However, there is now more evidence that the US labour market is finally cooling: the number of job openings in July fell to levels not seen since early 2021, and the unemployment rate jumped to 3.8% in August, although that was largely due to a rise in the number of people looking for work. Job growth has averaged just 150,000 per month in the three months to August, the lowest average growth in jobs since 2019 (excluding the depth of the pandemic in Q2 2020 when it was negative). Perhaps most encouragingly for the Fed, average hourly earnings grew at the slowest pace in August since February 2022. Although the Fed is likely to keep talking tough, possibly keeping another 25bp hike in its updated interest rate projections this month, we think the benchmark Fed Funds rate is at its peak.
While upside risks to inflation remain – food prices globally have started to rise, as have energy prices – growth outside the US is lacklustre. Recent survey data for the Eurozone points to a contraction on the back of a weak manufacturing sector, and preliminary PMI data for the UK in August was also much weaker than expected. While inflation in both the Eurozone and the UK remains higher than in the US, central banks may be more reticent to raise rates much further given their much weaker economies.
Recent weeks have seen no shortage of reports pointing to disappointing economic data from China also. Expectations had been high for a material surge in growth as China abandoned the remaining zero-Covid policies at the beginning of 2023, but it now seems likely that Chinese growth will only just match the (relatively low by historical standards) 5% growth target announced at the beginning of the year.
Slower growth in China ultimately means lower global growth. This would usually be met with easier monetary policy (ie rate cuts), but we think the probability of that happening this time is much lower, primarily because inflation is still far too high in too many countries.
While we believe developed market central banks are likely at or near their terminal rates, they will probably need to remain there well into 2024.
Emerging market central banks have already started to lower policy rates, as they were the first to tighten coming out of the pandemic and seemingly have inflation tamed. Latin America’s central banks have led the way, with Chile, Brazil, Uruguay and Costa Rica cutting rates in recent months. The People’s Bank of China has also reduced rates and extended other measures to support the economy.
However, there is reason for caution as rising food and energy prices may slow disinflation in emerging markets in the coming months. Higher-for-longer US rates are also likely to be a limiting factor on emerging market central banks as they seek to ease monetary policy and support growth in their economies.
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