“Its not over, not over, not over, not over yet“
The Klaxons, Not Over
Last week, we discussed what we saw as a continuation of the recent theme of completion of the global monetary tightening cycle (with the notable exceptions of Japan and China) with a focus on policymaker rhetoric ahead of this week’s important US data - CPI and Retail Sales. We argued that from our perspective, there had been a further consolidation of the (albeit relatively slow and careful) change in stance from the Fed. Essentially, stating that the Fed now appear to be increasingly comfortable that the current policy settings are ‘sufficiently restrictive’ and thus having the desired effect of bringing inflation back to target - even if they remain uncomfortable in offering any prescriptive forward guidance.
We pointed out that at the November FOMC Chair of the Fed stated that above trend growth on its own was not sufficient in its own right to warrant higher rates - continuing to play down the concept of a mechanical relationship between higher growth and higher rates - and (among other Fed speakers) has offered a more conciliatory tone in relation to forward looking growth expectations. That sentiment from the Fed (albeit with maintained warnings that higher inflation, or maybe even unchanged inflation with higher growth, may warrant a higher rate path), has continued this week.
Furthermore, while we continue to see a soft landing in the US, and by extension a backdrop that remains supportive of risk assets (at least in the near term), we have continued to see further signs of rebalancing in the US and global economy. And that the rebalancing of supply and demand is likely to have notable implications for global rebalancing (or the correction of global growth divergence in favour of the US that we witnessed in Q3). Essentially arguing that Q3 marked a peak in global growth divergence, peak US exceptionalism, and likely peak yields.
The Data from the US were this week’s highlights.
With the moves that markets had witnessed in US yields and the USD since the start of the month (exacerbated in many respects by the weaker employment report for October), it could be argued that the burden of proof has switched from the absence of slower growth and inflation needed to prevent yields and the USD moving higher, to the absence of higher growth and inflation needed to prevent yields and the USD moving lower - subtle but important. This theme is likely exacerbated in the near term by market positioning.
The release of the US CPI print for October was an interesting case in point in this regard. While the headline (and core) readings showed bigger than expected disinflation, the miss was relatively modest. Many commentators have subsequently argued that the reaction was disproportionate to the magnitude of the ‘miss’ relative to expectations. We are inclined to see this as an example of the shift in the burden of proof.
This is especially true while the growth backdrop continues to normalise. Indeed, commentary from Fed speakers this week has continued to shift to a more balanced narrative, with increased frequency of anecdotal evidence or expectation of areas of economic weakness ahead.
Last week also saw the release of the US retail sales data for October, where despite a modestly higher than expected headline print muted the market reaction function, there was weakness outside of autos and energy and overall, the data highlighted a marked slowdown from (an albeit upwardly revised) Q3. Evidence that the US growth backdrop is moderating is increasingly dominant. As yet, we are not expecting anything more sinister from a growth perspective - more of a rebalance than recession.
On inflation, however, we find ourselves increasingly on the other side of the dominant market commentary - that a series of factors (deglobalisation, the green transition, continued higher fiscal trajectories, tight labour market and high worker wage expectations and, even an increasing prevalence of geopolitical crises) will keep inflation, and thus monetary policy rates higher for longer. We are more inclined to see the prospect of any of these individual factors as limited to one off shocks to supply and demand and not a sustained mismatch - especially against a backdrop of weakening growth and still improving supply. This is more demonstrably likely in the near term, where we see a significant chance that headline inflation rates turn negative in many DM countries (just as we are currently seeing in the Netherlands) - Again this has significant implications for market sentiment and market pricing.
Ultimately, with the end of the year fast approaching - signified in the first part by a Thanksgiving shortened week in the US next week - we still think that there is plenty to play out in the market and thus plenty to pay attention to for the remainder of 2023 - and even more so in 2024! The data will continue to play a key role in the proceedings right up until the FOMC meeting on the 20th of December (wherein there may be time for a modest break).
For us this likely means a further extension of recent trends in risk assets, duration and the USD… as the Klaxons so succinctly put it, “its not over, not over, not over, not over yet”!
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Bank of England, November 2023 - https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/november-2023
FOMC, October 31. 2023 - https://www.federalreserve.gov/monetarypolicy/fomcpresconf20231101.htm
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