mince pies

“You usually have to wait for that which is worth waiting for“

Craig Bruce

Last week, we discussed what we saw as a continued evolution of the dominant themes that have been present for a number of weeks, but for which we have argued the macroeconomic case for, for even longer. Against the slower pace of the Thanksgiving holiday in the US, we argued that the most important theme was the renormalisation of global growth, or the correction of the divergent global trend of Q3 - often attributed to US exceptionalism - where US growth accelerated to close to 5% and the fragilities in global demand led to more acute concurrent weakness in the Eurozone and China.

This week, the revision to the Q3 GDP data was an interesting benchmark from which to gauge the growth deceleration in Q4. While the headline Q3 growth rate was revised higher to 5.2% q/q annualised, there are a number of supportive details to corroborate our view of a material slowdown in Q4 (albeit to still positive growth levels). Firstly, the upward revisions came in subcategories that are likely driven by CHIPS/IRA act flows that likely moderate going forward. A small inventory adjustment also added, but this mathematical increase will offset Q4 gains. The real takeaway, from what we see as a fiscally dominated Q3, was that gross domestic income was just 1.5% annualised; government spending and tax break-induced infrastructure building may well be a positive for long run productivity growth or the equilibrium growth rate, but it clearly overstates the current strength of the economy and is not sustainable.

Furthermore, with headline PCE declining to 3.0% y/y this week (lower than expected) the theme of continued disinflation and growth moderation that we have proffered from some time now is becoming more engrained.

Another point of note this week was the commentary from the Fed (Chair of the Fed still to come into the close on Friday). Richmond Fed Barkin noted that inflation heading back to 2% “makes the case for cuts”, even if that is not yet clear. Cleveland Fed’s Mester said that “policy is in a good place to assess incoming data” and perhaps most notably, given his recent stance at the hawkish end of the Fed spectrum, Governor Waller: not only did he infer that he is increasingly confident that policy is well positioned (i.e. not needing the additional rate hike this year that he signalled as recently as last month), given the “strong rebound in labour force participation”, but he also commented that if we see inflation continuing to moderate for several more months, then you “could see reasons to lower the policy rate.”! Circling back to our arguments for growth moderation, Waller also stated that forecasts show fourth quarter GDP growth should be 1-2%.

On the jobs front, also this week, we have seen continued claims (essentially a proxy for those receiving unemployment benefits) in the US mark a distinct change of direction in Q4 relative to Q3, where the trajectory of the data in Q3 (a modest but consistent downtrend) has given way to a sharp rise in Q4 (to the highest level since December 2021). Anecdotal factors that we are aware of, such as further reduced excess savings and the renewal of student loan repayments, are other factors that might suggest weaker demand growth, higher labour supply and weaker price pressures going forward.

On the broader concept of global growth convergence in Q4, we argued last week that the market pricing of rate cuts next year has become increasingly correlated across US, UK and Eurozone futures strips, thus highlighting a level of realignment of global growth correlations with significant implications for market pricing across wider asset classes (not least FX). This has continued. Similarly, we argued that the release of the global (with the notable exception of the US) PMI data for November has shown further signs of consolidation in the European data (admittedly with Europe still in contractionary territory), and a full stabilisation in the UK data. Essentially, we see this as an (albeit nascent) sign that the renormalization is in train; Europe stabilising and the US slowing. US Manufacturing ISM data into the close of this week and the ISM Services next Tuesday will be very closely watched for sentiment around the uncertain magnitude of US activity slowdown at the current juncture. Our inference here is that US exceptionalism in Q3 was likely the exception, not the rule.

Last week, we also touched on some recent encouraging consumption data, amid the ongoing incremental policy stimulus from the Chinese authorities. While we argued that recent measures likely go some way towards restoring confidence, the weaker than expected PMI data and the waning market sentiment following recent property support measures suggest more a targeted response may be required for a more durable rebound in domestic demand and domestic investor confidence. Overall, however, we continue to see encouraging signs for economic stabilisation and corporate innovation in China - albeit at a slower pace than we had hoped.

Perhaps the most significant development of the week has been the bigger than expected drop in eurozone inflation (and importantly core inflation). The drop in the headline was dominated by declines in energy components, but the core drop was driven by intensifying disinflation in core industrial goods and a further easing of services inflation. The initial reaction of markets was to mar EUR lower relative to the USD and European yields wider, relative to the US curve. However, we would continue to argue that the sentiment bias (negative on European growth and inflation, and positive on US growth and inflation) is too extreme, and we continue to be of the view that Q3 was a period of peak divergence.

Going forward, we expect the pace of disinflation to moderate in Europe and accelerate in the US - particularly if anecdotal reports of heavy discounting in US Black Friday/Cyber Monday sales (not to mention the sharp increase in by-now-pay-later purchases that likely trim future disposable income in addition to the renewed student loan repayments) prove correct. We continue to see a macro backdrop where further growth moderation and continued disinflation support risk assets (at least for now) and, from a cyclical perspective, after the dominance and outperformance over recent years, the USD looks increasingly vulnerable.

Last week, we argued that there was still plenty to play for in 2023. Indeed, the next couple of weeks are huge for US growth, inflation and monetary policy trajectories. As such, we will be holding off on the mince pies and eggnog for a while longer.

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