Twilight zone

Week in review

The third ‘Fed pivot’ trade this year – which essentially has been in place since mid-October – continued last week, with markets still basking in the growing likelihood that the US Federal Reserve will only raise rates by 0.5% at the December policy meeting to a range of 4.25-4.5%. Stocks rose, bond yields fell and the $US weakened a bit further.

Of course, Fed officials have been trying hard to stem equity market over-exuberance – by noting the Fed still plans to raise rates over coming months, with the Fed funds rates currently expected to hit around 5% by mid-2023. But after December, that still implies only one or two more rate hikes, depending on the the size of the remaining policy moves.

To my mind, markets are now in the ‘twilight zone’ – celebrating the potential end of the rate hike campaign but not yet focusing on the potential negative economic consequences. So far, of course, those negative consequences remain more risk than reality, so equity markets can keep living in hope. Indeed, neither the markets nor the Fed really are quite sure what will come first – a timely fall in inflation (avoiding the need for recession) or a recession. While US goods inflation is clearly on the way down, the tight labour market and high wage growth could be a floor under service sector inflation. If so, there’s no choice but to push the economy into a period of below-trend growth.

The other key global development last week was another surge in COVID cases in China, as the country attempts to extricate itself from its zero-COVID strategy. Hopes for a speedy rebound in the Chinese economy are likely to be disappointed at least for a few more months.

In Australia there were not many major highlights last week apart from a relatively unsurprising speech from RBA Governor Phil Lowe, who largely repeated familiar themes with regards to the interest rate outlook. The bottom line is that, compared to the US at least, Australia’s currently more modest pace of wage growth gives us a little more wiggle room to give the economy the benefit of the doubt and wait a little longer for inflation to fall.

Week ahead

There’s a smattering of key US economic data this week, including the consumption deflator (the Fed’s preferred measure of inflation) on Thursday (US time) and payrolls on Friday. All up, the data seem likely to show a ‘sweet spot’ of sorts, with both inflation moderating (albeit still too high) and economic growth slowing (albeit not enough to signal a recession).

As with the recent CPI report, the consumption deflator is expected to reveal a smaller monthly gain of 0.3% for October after a 0.5% gain in September – which could be taken as further reassuring near-term inflation news. Similarly, a goldilocks-like gain of 200k jobs is expected in Friday’s payroll report, with the unemployment rate steady at 3.7%. Of most interest, however, is likely to be the average hourly earnings result, with annual growth expected to moderate slightly from 4.7% to 4.6% (which is still too high).

In Australia we get a set of building blocks for the Q4 GDP result, including construction work and business investment – both of which are likely to be positive. Retail spending on Monday and building approvals on Wednesday round out the week. Building approvals are likely to keep falling, consistent with high interest rates having the greatest negative impact to date on the housing sector, though retail spending (perhaps frustratingly for the RBA) is likely to remain firm.

Have a great week!

*Due to technical issues, this week Bites contains no charts or tables.