April 12, 2023 - Global View
A deeper look at what’s happening in the U.S. and around the world, including the global currency markets.
Summary
Thursday will be a big day for U.K. watchers, which is when the monthly GDP estimate for February gets released.
The March non-farm payroll report increased the odds that the Fed hikes at its May meeting.
The yen stalled out relative to the dollar when it was announced by new BoJ governor Ueda that its ultra-accommodative policy and yield curve control will remain in place indefinitely.
Last week’s non-farm payroll report came in right around what was expected, but the markets chose to take it as another hawkish signal for interest rate policy. The number helped shift the odds of a May rate hike to around 67%, although it’s likely to be the last one in the cycle. At this point, another quarter-point probably isn’t going to make a material difference for conditions later this year, but it does emphasize the fact that the Fed is still very focused on high inflation at the risk of accelerating the arrival of a recession. When the labor market data is taken in totality, it actually paints a pretty mixed picture. The JOLTS data showed job openings at a 21-month low. The Challenger Job Cuts report indicates that layoffs have more than doubled in the past six months. The March non-farm payroll number was the lowest monthly gain since December 2020. Even as the unemployment rate remains incredibly low, there’s significant evidence here that the labor market is cooling. Since that’s consistently been a key factor for the Fed in setting rate policy, it looks like the central bank has already overtightened and may need to reverse course quickly in the 2nd half of this year.
The markets are also waiting on the latest round of inflation data this week, not just in the U.S. but worldwide. At home, the year-over-year inflation rate is expected to drop from 6% to 5.2%, which would be the lowest reading since the 1st half of 2021. The core inflation rate, however, is expected to remain stuck around 5.5%. The data is still working off a few more months of high base effects before the annualized rate dips into the 3-4% range, where it’s likely to remain for a while. This will present a very interesting problem for the Fed. Does it abandon its laser focus on inflation, satisfied that bringing the annualized rate down to this range qualifies as sufficient progress? Does it turn its focus to mitigating recession risk given the direction of the data? Does it try to address both while focusing on neither? Back in the 1970s, the Fed Funds rate was cut by more than 700 basis points after inflation had peaked, but it also contributed to a second bout of inflation that was even worse by the end of the decade. It’s not out of the question that a similar path could play out again.
In terms of equity behavior, small- and micro-caps are looking really ugly here, although they’ve rebounded a bit this week so far. The underperformance started around the time that SVB went under and spilled over into vulnerable risk assets. Small-caps are more exposed to the financial sector than large-caps and smaller banks are more exposed to the commercial real estate market. The former issue looks like it’s going to fade as more time passes, but the latter could be a problem. We’re still in the early innings of a real estate & housing market downturn and it’s only likely to get worse as recession risk grows. Utilities are looking pretty strong here. Transports are weak. All signs that investors are getting more defensive.
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