Given the steep losses many
investors have experienced in recent weeks, many want to identify the culprit that is
responsible. Two
have emerged. Federal Reserve Chair Powell and Russian President
Putin. Putin's threat may have encouraged some risk adjustment, but
looking back at February 2014, when Russia invaded Crimea and annexed it, it
should not be exaggerated. If anything, the S&P 500, for example may
have gained a little, depending on the exact dates one uses.
The same is for the Swiss
franc against the euro.
The franc rose to six-year highs against the euro last week. In 2014,
when the SNB was capping the franc (floor for euro at CHF1.20), there did not
seem to be much pressure on the cross. In fact, domestic sight deposits,
which offers insight into intervention, fell from mid-February 2014 through
mid-March. Gold rallied about 5% from the February 23 invasion to March
17. It gave it all back plus more by the end of the month.
It is easy to blame the Fed
for the stock market sell-off, after all many claimed it was responsible for
lifting valuations to such extreme levels in the first place. Yet, it is a bit more complicated
than simply the Fed is going to tighten so sell stocks. Indeed, the data
presented by MarketWatch's
Mark DeCambre shows that more often than not, the S&P 500 rallies
over the course of most Fed tightening cycles.
On the other hand, to twist a
phrase from Orson Welles, if you want an unhappy story, you must know where to
end it. Goldman
Sachs's Chief US equity strategist David Kostin who was quoted on Yahoo Finance
notes that on average in recent cycles, the S&P 500 sells off 6% in the
three months after the first Fed hike and then recovers almost fully in the
next three months.
With the volatility of
equity markets and the risk of conflict in Europe, risk is sucking up oxygen. Three events - central bank meetings, the eurozone's December CPI, and US jobs
will dominate the agenda. Of note, China's markets are closed for the entire week, and before the markets
re-open, the Beijing Winter Olympics will begin (opening ceremonies February 4)
amid a flare-up of Covid cases.
Central Bank Meetings
1. Reserve Bank of
Australia: The market
has been pressing that the RBA needs to hike rates considerably sooner than
Governor Lowe has allowed. The central bank's forward guidance is for a
rate hike late next year or early 2024. The market has not thought this
was a reasonable stance for some time. Consider that with a 10 bp cash
rate, the one-year swap first rose above 80 bp at the end of last
October. It was still near there on January 10, and last week sustained a
move above 120 bp. By January 25, when Australia reported higher than
expected Q4 CPI (3.5% year-over-year, up from 3.0% in Q3 and above the
Bloomberg median of 3.2%), the swaps market had made its move. The central
bank emphasizes the underlying rates (trimmed and weighted medians), which are
at eight-year highs. The RBA will likely begin capitulating at this
meeting. It may begin with an upgrade of its labor market and price
outlook. The RBA could announce the end of its bond buying after.
It will leave some room to allow a hike this year. This may
translate to a hawkish hold for the RBA, but it still would not have caught up
to the market. The $0.7000 area is technically a critical area. At the very least, it frayed ahead of the weekend. That said, the non-commercials (speculators) in the
futures market have only trimmed their record net short Aussie position by a
little bit through Tuesday, January 25.
2. Bank of
England: After a
stutter last November, the Bank of England hiked the base rate 15 bp in
mid-December 0.25%. With inflation rising, and rising faster than
expected, and robust job growth and a 4.1% unemployment rate (3.8%-3.9% in
2019), there is little reason not to expect another rate hike this week. The
swaps market has priced in no less than a 75% chance in recent weeks. The
swaps market has 100 bp of tightening discounted for this year. Governor
Bailey indicated that when the base rate rises to 0.50%, which will be this
week with a quarter-point hike, the BOE will begin allowing its balance sheet
to shrink by not rolling over the maturing proceeds. There is a large
maturity in March. In addition to the two-pronged monetary tightening,
the UK economy is being asked to withstand a strong bout of fiscal
tightening. Consider that the budget deficit is expected to fall to 3.9%
this year after a little more than 8% last year (median forecast in Bloomberg's
survey). Political pressure remains on Prime Minister Johnson.
Assuming he would not resign, a leadership challenge is the other path.
However, ahead of the May local elections this may be too bitter of a pill for
the Tories to swallow, abandoning the impish prime minister that delivered
Brexit as such and led the party to regain its parliamentary
majority.
3. European Central
Bank: In
contrast to the Bank of England there is little for the ECB to say or do.
The strategy through Q1 is in place and there is no urgent need to alter
course. And this is doubly true without new staff forecasts. The
spring wage round is important, and the market expects the ECB to likely move
later this year. The swaps market is pricing in 20 bp higher rates over
the next 12 months, and back to zero by the end of 2023. The preliminary
estimate for January CPI will be published the day before the ECB meets.
Traditionally, that is before Covid, prices would often fall in January.
Last year was the first time in more than a decade that prices did not
fall. It is expected to have reverted back to form, and the median forecast (Bloomberg) is for a 0.5% decline in the month-over-month measure, which would bring the year-over-rate down toward 4.5% from 5%. The core rate is seen at 1.8%, down from 2.6%. The German VAT is a key factor. It contributed to the upside and now the downside. The hawks may feel a little restrained, though they remain less convinced than President Lagarde that the price pressures will subside with Covid and the repair of supply chains. The ECB's Chief Economist
Lane provided a blueprint of the central bank's logic. He said that if
the goal is inflation around 2%, and conceding 1% productivity grow, wages to
achieve inflation target. What follows from that is wage growth must
average more than 3% for the ECB to hike. Portugal goes to the polls on January 30 but will likely stick largely to what
they have. The French presidential election is not until April, but
Macron's declining support may keep it in the news.
4. EM: Two emerging market central bank meetings
are notable. Brazil's central bank meets on February 2. It has
already signaled another 150 bp hike that would lift the Selic rate to
10.75%. It would be the third hike of this size beginning last October,
and it followed two 100 bp increase in Q3 21 and three 75 bp moves in H1
21. With last week's IPCA inflation CPI showing its second consecutive
slowing (to 10.2% after peaking at 10.73% last November), investors seem to be
getting more concerned about growth. The IMF's latest forecasts warn
growth will slow to 0.3% this year from a little less than 5% in 2021.
Several bank economists are talking about contraction. One
important takeaway is that rates are near a peak.
The Czech central bank meets on
February 3. The question is not if but how much rates are
increased. The central bank has hiked at every meeting starting last June
and is not done. The policy rate (two-week repo) is at 3.75%. It
was at 0.25% as of last May. The market seems divided between a 25 and 50
bp move. Inflation jumped to 6.6% in December, but the base effect is
favorable for a substantial drop in January. Recall that in January 2021,
CPI surged 1.3% on the month. Hungary (7.4% December CPI year-over-year) has
been very aggressive and its one-week deposit rate has been ratcheted from 0.90%
in July 2021 to 4.3% last week. Poland (central bank meets on February 8)
has become more aggressive after lagging the other two. Its reference
rate was at 0.10% as recently as last September. It has been hiked four
months in a row to stand at 2.25%.
Jobs Data
Last week's Bank of Canada
and FOMC meeting may dampen the market's reaction function to the January
employment reports. The jobs data are often important because of what it reveals about
the economy and the impact on policy. As labor slack gets absorbed in
both countries, slower job growth should be expected, but the vagaries around
the Covid disruptions and faulty seasonal factors may inject more volatility
into the data.
In fact, US non-farm payroll
growth has slowed.
The average monthly gain was 365k in Q4, the lowest quarterly average of
2021. After an increase of 199k in December, non-farm payrolls are
expected to rise by a little more than 200k, helped by a 35-40k increase in
government jobs. Recall in 2019 that US jobs rose by nearly 170k on
average a month, and in 2018, the average was almost 195k. The unemployment
rate is derived from the household survey, and it is expected to be unchanged
at 3.9%.
The average work week may
have ticked up, and it could be related to the Covid-related absenteeism. Recall that in January 2021, the average
work week spiked to 35 hours. Yes, 35 hours, is the highest in many years
since at least before the Great Financial Crisis. The average
workweek was 34.7 hours in H2 21.
One element that may
cause some consternation average hourly earnings are likely to continue to
accelerate through at least the first part of this year. The median forecast in Bloomberg's
survey calls for a 0.5% increase, which matches the monthly average for H2
21. Yet, due to the base effect, it will be sufficient to lift the
year-over-year rate back above 5%. At 5.2% it would match last
year's quickest pace. It is possible that the earnings data overtakes the
modest jobs growth as the key to the market's reaction.
The Bank of Canada passed on
its first opportunity of the year to hike rates last week but left no doubt
that the cycle will begin at its next meeting in March. It noted that the output gap had
closed. Almost regardless of specifics of the January jobs report, the
Bank will not be deterred. Consider that full-time positions grew by an
average of almost 95k in H2 22. Adjusting for the relative populations,
it would be as if the US created a million jobs a month. In 2018 and
2019, full-time jobs grew at an average monthly pace of about 18k and 25k,
respectively.
Canada has also done a
better job of integrating more of its population into the labor market than the
US. On the eve of
the pandemic, the participation rate in Canada averaged 65.5%. In the US,
it was closer to 63.2%. At the end of last year, the Canadian participation
rate had almost completely recovered to stand at 65.4%. In the US, it reached 61.9% in November and remained there since December.
Disclaimer
Reviewed by Marc Chandler
on
January 29, 2022
Rating:
