Five charts that matter for investors
Julien Lafargue, CFA, London UK, Chief Market Strategist
Supercore inflation to the rescue
Last October we highlighted in our top 5 charts that live data suggested that US housing-related costs were due to come down. This is still the case, with the Zillow all houses rent index at +6.9% year-over-year in January, down from +9.6% in October and +17% at the peak a year ago.
With energy prices falling too and US Federal Reserve (Fed) chair Jerome Powell acknowledging in the latest FOMC press conference that the process of disinflation has started when it comes to goods, investors have been narrowing their focus on what is now known as “supercore” inflation.
Supercore inflation comprises services inflation excluding housing and energy. It includes a narrow subset of the inflation basket made of transportation and medical-care services as well as other services such as club memberships, education or haircuts. The idea behind supercore inflation is that it represents the only parts of the consumer price index for which – at this time – the jury is still out as to whether price pressures will subside.
The good news is that, according to January’s data, supercore inflation is weakening, confirming that, with goods and housing inflation also receding, overall price increases are set to slow in coming months. In turn, this might mean that the Fed is more or less done when it comes to interest rate hikes, or at least that’s how the market sees it.
No more rate cuts in 2023?
Supercore disinflation may suggest that the Fed is done hiking, but that does not mean it will cut interest rates this year. Three months ago, Fed funds futures suggested that the US central bank would bring interest rates below 5% during the second quarter of 2023, and then soon start cutting rates to 4.5% by the end of the year and towards 3.5% by December 2024.
But with a much stronger-than-expected US job market this year and only very modest disinflation, markets have adjusted their expectations. Now investors expect the Fed to push interest rates closer to 5.4% and keep them there into year-end with less than a full hike priced in for 2023. The end-point in 2024 has remained unchanged though, suggesting a more aggressive series of cuts next year.
Our view has long been that the market was too quick in pricing in cuts, as it would require a significant deterioration in the macro landscape for the Fed to undo all its hard work. Now, we feel that the market is more reasonably priced, although the rates trajectory in 2024 remains highly uncertain (see chart). But with disinflation underway and with cuts already anticipated, locking in rates seems to be a sensible move.
Good news galore
Eurozone equities have outperformed their US counterparts in recent weeks (see chart). The drivers behind this unusual surge have been well publicised: a warmer-than-expected winter removing the risk of an energy crisis, the reopening of China’s economy providing a boost to growth and particularly bearish investors’ positioning going into the winter.
However, like all good things, this broad-based outperformance may come to an end. Indeed, looking at the degree by which European economic data have outperformed expectations, it seems that there is little room left for the data to improve relative to current forecasts.
On the other hand, the data coming out of the US and the UK have failed to impress recently and could turn the corner just as investors become too pessimistic. As we know, what matters is not the absolute level of economic growth but rather its direction. In other words, the second derivative, when it comes to US and UK economic data, is set to improve and this could take the wind out of the sails of European assets in the short term.
In the longer term though, earnings will hold the key as to whether the eurozone’s indices can continue outperforming.
Pick up the phone
As central banks become increasingly data dependent, investors are watching economic releases in a bid to decipher where monetary policy is headed. In the case of the US Federal Reserve, the dual mandate of maximum employment and stable prices means that markets have to pay attention to both inflation and job market data.
The labour market has been hot for many months, and with more than 11 million job openings, according Job Openings and the Labor Turnover Survey (JOLTS), there are twice the number of positions waiting to be filled as there are jobseekers.
But the JOLTS survey, like many other indicators, has seen a significant drop in response rates in the past five years. In October 2022, only one in three of the 21,000 companies contacted to provided details on jobs openings, hires and quits provided a response (see chart).
This trend is worth monitoring, as the data policymakers and investors rely on to inform their views on the US economy and markets may not be a full and true reflection of reality.
A restocking story
US companies appear to be rebuilding stocks. The inventories component of the ISM manufacturing survey has shot up to 46.9 in February from 39.5 in July, though remains in contraction territory (see chart).
Over the same time frame, the new order component has dropped to 47.0 from 48.6, having hit a low of 42.5 in January, indicating less demand for companies’ products.
The combination of higher inventories and lower sales points to a slowdown. In fact, when the differential between these two components of the ISM survey drops below -15, a recession is usually just around the corner. At zero, we are not there yet, but a further decline would challenge further the “soft landing” scenario that has become so popular recently.