Taking Stock: Traversing Table Mountain

Investors go into this week hoping for some relief. The implications of ‘higher for longer’ interest rate policies from the major central banks are weighing on risk assets and at the same time, pushing up Treasury yields.

What relief might they find? Friday’s non-farm payroll data is expected to show 150,000 new jobs were created in September, down from 180,000 the previous month. If this happens, it will be good news for those hoping for a more dovish outlook on rates from the Fed and stocks should benefit.

But the labour market data is ambiguous. The unemployment rate is likely to fall, from 3.8% to 3.7%, suggesting still-strong hiring conditions. A rise in labour union activism, notably in the auto sector, confirms this.

Oil may cross $100 a barrel this week. Investors would welcome an assurance from central banks that they remain focused on core inflation and that they see a rise in energy prices as transitory.

The crossing of Table Mountain, as the Bank of England refers to its ‘higher for longer’ interest rate policy, is not going to be tranquil. Investors can avoid being buffeted too much, by investing in broad-based, multi-asset portfolios. Financial history shows these will deliver the best long-term returns, adjusted for risk.

Shutdown avoided- markets likely to shrug

The Rubicon has been crossed on Capitol Hill. House Republicans voted on Friday, with Democrats, to avoid a government shutdown. The deal was put forward by House Speaker Kevin McCarthy. Relying on Democrat votes was something that he had promised his Republican hardline backers that he would never do.

Does this mean the apparent stranglehold of Republican hardliners on the party has peaked? Perhaps. But do not expect the hardliners to collapse, more likely fierce internal wrangling amongst House Republicans as the hardliners attempt to regain authority.

When Julias Caesar crossed the Rubicon River, in 49 BC to attack Rome, a civil war followed (which incidentally, he won). The current deal last for 45 days, we can expect more hostilities within the House Republican caucus over the next six weeks.

But for investors, in the near term at least, the deal is unlikely to have much impact and neither will civil war in the House Republican party. As we noted last week, neither the U.S. government debt market nor stock markets appeared perturbed by the looming threat of a government shutdown.

Traversing Table Mountain

The ‘higher for longer’ interest rate theme cast a shadow over global stock markets last weeks, as investors contemplated the implications of central banks delaying interest rate cuts until well into next year.

But on Friday, bond investors received good news on inflation, from both sides of the Atlantic. In the U.S., the core PCE, the Fed’s preferred measure, came in at 3.9% for August (from 4.3% the previous month).* In the Eurozone, August CPI fell to a two-year low of 4.3% (from 5.2% in July).**

Leading indicators are already weak, suggesting a period of low growth and less pressure on labour markets, which will in turn reduce wage/price pressures. We have manufacturing PMIs below 50 in all the major economies (suggesting contraction), last week a 3.2% fall in global trade in July (compared to the previous year) was reported.

A recent downward revision to global growth, from the OECD pencils in 3% for this year, and 2.7% for next. Anything below 3% is considered deflationary.***

However, until labour markets weaken and provide what economists call ‘output gaps’ (others might use the word ‘unemployment’), we are unlikely to see a change in central bank policies. It may take some time to traverse the plateau at the top of Table Mountain.

Perhaps surprisingly, given the risks to growth, long-dated Treasury prices continued to slide (and their yields rose).

One explanation is that bond investors are concerned that ‘higher for longer’ will lead to higher long-term inflation expectations, which will prove difficult to bring back down. Rather than Table Mountain, the argument goes, perhaps a Matterhorn approach to interest rates might be better (a short, sharp peak)?

Certainly, if the priority is to squeeze out inflation, without regard to growth and the implications for the financial system, such an approach would probably work. But, as the cliché goes, anyone can cure an illness by killing the patient.

Sources:

* https://www.bea.gov/data/personal-consumption-expenditures-price-index-excluding-food-and-energy

** https://www.reuters.com/markets/europe/euro-zone-inflation-falls-lowest-2-years-economy-slows-2023-09-29/

*** https://www.oecd.org/economic-outlook/september-2023/

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