“I hear trouble coming“
Royal Blood, Trouble Coming
Last week, we discussed the most recent monetary update from the Bank of England. The MPC voted to leave rates unchanged at 5.25% (As expected), with two members maintaining their preference for an immediate 25bp rate cut. We discussed the statement of the Bank that highlighted their expectation that inflation will rise moderately through the remainder of 2024 (due to the positive base effects of energy price declines in H2 2023) despite CPI falling to its 2.0% target in May from 3.2% in March. Indicators of short-term inflation expectations have also continued to moderate, particularly for households.
On the labour market, we highlighted what we saw as the significant notion from the Bank in highlighting the “considerable uncertainty around estimates derived from the ONS Labour Force Survey means that it is very difficult to gauge the evolution of labour market activity”. The MPC judges that the labour market continues to loosen but remains relatively tight by historical standards, and aggregate pay growth has continued to ease - both factors that we continue to see as facilitating rate cuts as the labour market continues to cool.
Interestingly, on the subject of services inflation, which remains at a level above that projected in the May Monetary Policy Report, the minutes played down services inflation persistence concerns, suggesting “this strength in part reflected prices that are index-linked or regulated, which are typically changed only annually, and volatile components”. We argued that this was another very important point as it argues against excess demand for services, keeping prices high and thus policy rates high - another clearly dovish statement.
Restricted consumer?
Ultimately, the Bank were clear that “the restrictive stance of monetary policy is weighing on activity in the real economy, is leading to a looser labour market and is bearing down on inflationary pressures”. In particular, and again something that was noted in the minutes, the emphasis of the impact of the restrictive level of rates is at the consumer level. This week, despite a pick up in the consumer spending component of the Q1 GDP revision, there was a clear rise in the savings rate (a clear sign of a more cautious consumer going forward). Furthermore, the Bank of England’s twice yearly financial stability report noted Household resilience, but also clearly stated that “many remain under pressure”.
Emerging weakness?
Over recent months, we have suggested that we see the consumer as weaker than the headline data has suggested in the UK but most notably in the US. Recent data, however, appears to be converging lower. This week, we have seen US consumer confidence (while in line with expectations) continue to trace a modest, and arguably still declining, path. The Atlanta Fed Nowcast GDP for Q2 was also revised lower this week following the further rise in continuing claims in the US (now at the highest level for the series since the end of 2021).
This week also saw the wider discussion of a California legislature (LAO) report highlighting a significant downward revision to job creation in California. The report discusses recent revisions to data that initially saw job growth of 117,000 in the 4th quarter of 2023 but now show a decline of 32,000. This is very important.
The importance of being earnest?
We have argued in many pieces that the Fed monetary policy reaction function remains the most acutely sensitive to changes in the labour market against the current inflation path (Sharply lower than the peak but still modestly above target). With US rates well into restrictive territory, any signs of weakness in the labour market can bring forward rate cuts significantly in the US
If we consider the slowing in consumption metrics in the US that have been more apparent in the recent data and the potential business investment (hiring) uncertainty in the build-up to the election - not to mention the recent analyst reports suggesting we may be at a tipping point for the unemployment rate as the jobs gap appears fully closed - remain indicative of a loosening labour market.
Next week is a huge week for the US labour market and, thus, by default, a huge week for Bond markets, Equity markets and the USD.
The importance of being earnest?
For much of this year, inflation has been the dominant macro factor, and the higher-for-longer narrative emanated from this popular thesis (one that we pushed back on throughout). However, in the current macroeconomic configuration, growth is the dominant factor, and within that is the unemployment rate. From our perspective, for US employment, to paraphrase Royal Blood, trouble’s coming!
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