Powell to pivot?

A good week for

• Emerging market equities rallied over 2% in sterling terms
• US and European government bonds strengthened in local terms as rate hike expectations eased

A bad week for

• Japanese equities weakened, hindered by yen strength
• UK government and corporate bonds declined

US monetary policy

US Federal Reserve Chair Jerome Powell pointed to a slower pace of monetary tightening ahead, boosting investor confidence. In a speech at the Brookings Institution, Powell suggested that rate hikes could slow “as soon as December”, with “slowing down at this point…a good way to balance the risks” created by monetary policy. Because policy works with long and variable lags, the full impact of the tightening already enacted may not be felt for some months, creating a risk of over-tightening. However, Powell again reiterated that “restoring [supply and demand balance] is likely to require a sustained period of below-trend growth” and that the labour market remains tighter than is compatible with price stability. The news weighed on the US dollar, and boosted the prices of US government bonds. However, the Fed has made it clear that the path of monetary policy will still depend on how economic data evolves, especially in the labour market. The wait for a ‘Powell pivot’ goes on.

US labour market

Friday’s labour market report did not point to continued easing as the market and the Fed had likely hoped. While the unemployment rate was unchanged, as expected, a number of other measures indicated more sustained tightness. Non-farm payrolls rose by 263,000, ahead of the October print and stronger than economists had expected for November. Wage growth also accelerated to 0.6% month-on-month, taking the annual growth rate to 5.1%. Meanwhile, the labour force participation rate dropped back to 62.1%. Given the important role of wage growth in core inflation, the labour market needs to weaken further for the Fed to confidently end rate hikes.

US economy

While US labour market data remains robust, some forward looking US indicators do suggest slowing economic growth. The Manufacturing ISM index fell to 49 in November, below the “50” level that signals economic contraction. Within the report, prices paid, new orders and employment indices all weakened. The Job Opening and Labour Turnover Survey also signalled some slowing. The ratio of job openings to unemployed workers once again fell to 1.7x having rebounded, with job openings falling by 350,000. While hiring activity slowed, the number of workers switching jobs voluntarily remains elevated. While layoffs rose modestly, the level is below the pre-pandemic average. However, labour demand did cool noticeably in those sectors most sensitive to interest rates, such as construction and manufacturing, suggesting rate rises are having an impact.

European inflation

Interest rate expectations moderated in Europe this week, as inflation finally showed signs of abating. Consumer price inflation cooled to 10% in November, from 10.6% in October. On a month-on-month basis prices fell -0.1%. However, with most of the downward pressure coming from energy prices, core inflation, which excludes energy and food, remained elevated at 5%. Last week ECB officials spoke out against slowing the pace of tightening, given the challenges faced by the supply side of the economy. However, with high energy prices expected to weigh on Eurozone industrial production this winter and inflation likely slowing, the ECB may wish to take the Fed’s lead and slow down the pace of tightening. Given that the ECB’s 2023 forecasts are likely to be downgraded, and new 2025 forecasts will probably predict inflation below trend, the tone may be more moderate in the new year.

China

After growing protests, China’s leaders are rumoured to be planning an end to strict zero-Covid social restrictions. Changes to central government policy have already allowed many cities to relax restrictions currently in place to control the latest surge in cases, but 25% of the economy remains in some form of lockdown. Many regions have launched plans to accelerate vaccinations for the elderly, targeting 90% of over 80s by the end of January. This is an essential target if China is to reopen in the spring, alongside better provision of treatments for severe cases.

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