The US Economy Still Looking in Rude Health
Central Bank week has come and gone, and to be honest, with very few shocks delivered for the financial markets. The US Federal Reserve, still by far the most hawkish of the central banks, raised by 75bp, which came as no surprise to most, nor did their policy of potentially having gentler rises but a higher for longer terminal rate. After initially encouraging those looking for the Fed to pivot, Chairman Powell’s speech made clear that there was no chance of the Fed changing track anytime soon. Their approach is understandable with the US economy still in rude health, as last Friday’s robust employment data showed. The Fed now looks like the outlier in terms of hawkishness partly due to the easier fiscal policy that President Biden is committed to, and appears to be the most resolute inflation fighter. Their hawkishness will most likely encourage further dollar strength for the foreseeable future.
Of course, there is always one that manages to make a mess of its communication with the markets, and that was not unexpectedly the good old Bank of England, who yet again worked hard to grasp defeat from the jaws of victory. After raising Base Rate by 75bp, it managed to curb the currency markets’ new-found enthusiasm for the pound by pushing back on the market’s expectations of further tightening. The sterling derivative markets were looking for a terminal rate of 5%, which the Old Lady warned would lead to a three-percentage point contraction in the economy. The markets immediately scaled back their forecasts for the next move upwards in December from 75bp to 50bp. The pound again came under selling pressure after this dovish turn from the Bank of England, which primarily drew attention to the fragility of the domestic economic outlook. Sadly, it does appear to be the case that the Bank of England’s credibility as an inflation fighter is in some doubt and with a muddled fiscal policy, the pound looks set to retest the lows against the dollar it saw earlier in the year. And, of course, as the currency falls, it imports more inflation.
The week ahead sees some relatively important data releases in the UK but not till the end of the week when there is a veritable plethora of economic information to digest. The pick of the bunch is likely to be 3rd Quarter Gross Domestic Product which is expected to show a contraction. This is hardly surprising with all the political and financial uncertainty over the last quarter. Having seen the Bank of England erring on the side of caution with its policies, the markets certainly won’t be expecting a surprise on the upside. Industrial and Manufacturing Production are also scheduled for Friday and will probably make for pretty grim reading. Now that the members of the Old Lady’s Monetary Policy Committee are out of speech blackout, they will have the opportunity to speak about their recent actions. The speakers start this morning with Sarah Breeden, followed by Huw Pill tomorrow and continue through the week ending with Silvana Tenreyro on Friday afternoon. Will they reassure the markets …well let us just leave that question hanging there.
The euro is also suffering from dubious central bank speaking with Christine Lagarde. Last week she said that the current inflation came from “nowhere”, which is undoubtedly one of the stranger comments that the ordinarily urbane ECB president has come out with. Apart from that, she actually has been quite resolute in her statements on fighting inflation, and a further 75bp rise looks set for December. But the euro still looks set to struggle against the mighty dollar and could, along with sterling, revisit its lowest levels. The week ahead is relatively barren on the data docket, with only second-tier data for most of the week until the German Consumer Price Index release on Friday, which is estimated to be once again 11.6%. Still, there may be a shock in store as the recent input price index was soaring, which of course, influences the CPI data.
Finally, we turn to King Dollar, which after a stellar week, gave back some gains on Friday partly on hopes of China reopening and later on rumours that Putin was ready to enter peace talks. We will find out whether either of these is more than Friday afternoon pieces of gossip as this week unfolds. What was certain, though, was that employment is still holding up well in the US, which has dampened any thoughts that the Fed will pivot on its policy. Another indicator for the Fed to judge how its policies are doing will come on Thursday when October’s Consumer Price Index is released, which is forecast to have dipped slightly to 8%. If the number is lower than expectations, the market may again speculate that the Fed may pivot on its policy. However, there are two points to make: first, one swallow doesn’t make a summer, and second, even at 8%, it’s four times the Fed’s target. The month-on-month core number may be the key number here which is being called at .5%, still nowhere near low enough to cheer the Fed. What may be of more interest is the Michigan Consumer Sentiment reading released late Friday afternoon, which with the US having a Public Holiday, may not have an immediate impact.
In a pleasant change from our domestic politics taking centre stage and a welcome distraction from Matt Hancock, the mid-term elections take place in the US. Without a doubt, there are certainly many more knowledgeable observers of the US political screen than this scribe, but there are a couple of thoughts we have. Firstly, if the Democrats lose control of Congress, President Biden will struggle to get legislation through which will restrict his fiscal stimulus and could hasten monetary stimulus through lower rates. Finally, and not necessarily the best thought to leave you with on a wet Monday morning …it seems that whatever the result Donald Trump will be encouraged to throw his hat into the ring for the 2024 Presidential election.