Raising into recession?

A good week for

• Non-US equities rallied, led higher by emerging markets
• Oil gained c. +3% on a trade weighted basis

A bad week for

• Bonds weakened, led lower by Europe (-1%)
• Sterling fell 2-3% against main currency pairs

UK economy

The Bank of England (BoE) accelerated the pace of monetary tightening at the same time as downgrading GDP forecasts on Thursday. The BoE’s Monetary Policy Committee voted to raise rates by 0.75%, compared to 0.5% at its last meeting, in response to a still-tight labour market and strong wage growth. However, with real wage growth expected to remain negative through much of 2023 and 2024, weak consumption growth is likely to weigh on the economy, with the resultant potential recession anticipated to last until 2025. This period of weak growth should quash inflationary pressure within the economy, with inflation expected to fall below 2% by 2025. The weak growth and inflation forecasts were interpreted as a dovish signal from the Bank, coupled with explicit guidance that the rate path implied by the futures markets was too high. However, the Bank’s forecast includes several sources of upside risk, which could see higher inflation. These include the path of gas prices and the Treasury’s decision about what support to offer households after the end of the Energy Price Guarantee in April 2023. Another source of risk is the path of unemployment, with participation remaining stubbornly low and labour market indicators showing greater strength than the Bank had anticipated.

US economy

The US Federal Reserve delivered a fourth 0.75% rate hike on Wednesday, taking US rates to 4%. The statement continued to hold a hawkish tone on inflation, emphasising that “ongoing rate increases would be appropriate”. However, it also laid the groundwork for a slower pace of rake hikes at some point, reflecting the fact that significant tightening has taken place and that this is expected to impact the economy with “long and variable lags.” Fed Chair Jerome Powell indicated that this could happen as soon as December. Nonetheless, Powell did emphasise that a slowing in rate hikes did not mean the Fed was any less committed to quashing inflation. We expect the Fed to continue tightening until the labour market shows definitive signs of slowing.

US labour market

Last week’s US employment data sent mixed signals to the market as to the pace of slowing. The Job Opening and Labour Turnover Survey (JOLTS) report showed a rebound in job openings, sending the vacancy-to-unemployed ratio back up to 1.9x, after a fall in August. However, both hiring and separations slowed. Friday’s labour market report was similarly ambiguous – the increase in payrolls were weaker than in October, but were ahead of economists’ expectations. At the same time, the survey-based measure of unemployment rose more than expected, despite a fall in labour participation. Wage growth also slowed somewhat on an annual basis. While there are some signs of easing in this data, the labour market is still very tight, putting continued pressure on wage growth, inflation, and thus the Fed.

China economy

Investors anticipated changes to China’s zero-Covid policy last week. Many had expected China’s leadership to announce changes to the health code at the Party Congress but no changes were announced. With a surge of cases underway, vaccination rates of the elderly are insufficient to provide adequate protection without strict rules. However, last week Beijing was rumoured to be considering a relaxation of travel rules. The current scheme penalises airlines with travellers that test positive for coronavirus, banning them temporarily from those routes. China is also preparing to increase inbound flights, with a view to doubling them by the spring. However, over the weekend, Chinese officials spoke out, endorsing the zero-Covid regime, describing it as “the most economical and effective”. More detail on the eventual easing of health restrictions is expected by the end of the year.

Global food prices

Grain prices rose last week after Russia withdrew from an agreement to allow grain exports via the Black Sea. Exports to Europe are expected to be lower, but Africa and the Middle East are expected to be most negatively impacted. Ukraine contributes around 15% of global wheat and corn exports, with the war pushing food prices higher around the globe. With energy prices now easing somewhat, the upward movement in food prices is becoming more apparent in the inflation basket. This impacts low income households most starkly, as food makes up a larger share of spending.

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The information contained in this article is believed to be correct but cannot be guaranteed. Past performance is not a reliable indicator of future results. The value of investments and the income from them may fall as well as rise and is not guaranteed. An investor may not get back the original amount invested. Opinions constitute our judgment as at the date shown and are subject to change without notice. This article is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Where links to third party websites are provided, Close Brothers Asset Management accepts no responsibility for the content of such websites nor the services, products or items offered through such websites.