Skip navigation Scroll to top
Scroll to top

Weighing the labour market strength versus falling inflation

13 January 2023

Although Santa failed to deliver a rally, so far this year we have seen the market push higher across the board despite the circling hawks that previously soured the mood.

Royal Exchange

Jeremy Sterngold, Deputy CIO

On the surface, it is easy to see why the market started on a positive footing. For starters, German annualised Harmonised CPI fell back from 11.3% to 9.6% [1] versus expectations that it would remain in double digit territory. On a forward-looking basis for the Eurozone, there is good news too. The one-month forward Netherlands TTF gas future price is back to levels below the Russian invasion of Ukraine. The mild winter and high gas storage supplies have not only prevented any blackouts, but has also meant that manufacturers faced little disruption, albeit high energy costs. For governments, this is also good news. The fiscal headroom generated by these effects mean government deficits are not expected to be as large as previously envisaged. Given the widespread disruption of industrial action that we have faced due to the UK cost-of-living crisis, it may provide the government with the ability to come to an agreement without breaking the bank. 

While on the margin these changes improve growth prospects, the more significant development stemmed from China. After forcibly maintaining its zero-COVID policy for most of 2022, in December, the swift abandonment paired with measures to support the economy injected a dose of optimism. In the short term, the situation is likely to be challenging as there are lower levels of immunity paired with less effective homegrown vaccines, therefore it is likely that cases will rise significantly. This could result in some supply disruption for months to come, but longer-term growth prospects appear solid. The prolonged period of rolling restrictions combined with its ailing property sector has affected consumer confidence, resulting in a high savings rate. With support for both in place now, this could see consumption boost growth prospects later in the year.        

Over in the US, the picture has become more complicated. The labour market continues to be very strong with the unemployment rate falling to 3.5%, [2]matching the lowest levels since the late 1960s. On the other hand, survey data showed that the economy lost a lot of momentum in December. As such, investors were closely watching the inflation report released yesterday for clues to the Federal Reserve System (Fed)’s future policy. On the face of it, the expected 0.1% decline Month over Month (MoM) in CPI, gave investors some further evidence that price pressures are slowing which would warrant a softer stance from the Fed. However, while we see signs of positivity, we encourage not reading too much into this yet.

The “transitory” nature of goods inflation was shown to be in full swing. Second hand car prices fell 2.5% MoM, the same as overall transportation which accounts for 18% of CPI basket. Used cars have now fallen 8.8% Year over Year (YoY) after rising as high as 45% YoY in summer of 2021, representing a supply-side response after COVID demand and disruption. However, more timely surveys show second hand car prices stabilising. Furthermore, the news on housing was less positive as it increased 0.7% MoM taking the annual rate to 8.1%. Whilst the housing market has corrected which should impact the data over the coming months, given the swift increase in interest rates without a corresponding fall in the labour market, this may just be an adjustment. As such there is a meaningful risk that inflation could remain above the Fed’s two percent target over the medium term.

“Gimme, gimme shelter or I’m gonna fade away”[3]

Just as investors are hoping the inflation problem would fade away without the Fed being too aggressive, it is the shelter component combined with core services that may keep them hiking for a while longer. The 0.3% MoM increase in core pressures, paired with the last two core readings indicate that 3 month annualised core inflation is still running close to 3%.

Furthermore, while wage pressures are less acute, the Fed can hardly argue that the labour market is back in balance. As such, we should expect them to continue raising rates on the back of recent data. Although expectations have now moved towards a 0.25% increase at the February meeting, the risk remains that they opt for a 0.5% increase.

[1] German Federal Statistical Office

[2] US Bureau of Labour Statistics

[3] The Rolling Stones

 

Read more from The Brief.

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Wealth Management UK LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Wealth Management UK LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Wealth Management UK LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom.