Let us begin this week with a very rash assumption. Let us say that interest rates across the world have peaked. Now this may or may not be true, but for the purposes of this column this week, let us just work on the premise that the last fortnight’s increases in rates in the US, Europe and the UK are the last in this cycle. And hurray for that. The trouble is that there are consequences. Intended consequences.
Higher interest rates themselves do not directly affect inflation. Rates have been increased because the Banks believe that this will lower economic growth, and therefore the demand for goods and services. Thus if we are at the peak of the interest cycle, then the Banks are sure that they have caused sufficient damage to their respective economies to have shaken out this evil inflation (and let us not forget that this inflation was mostly of their own making). Which takes us back to the point about trouble from intended consequences. We have yet to see much evidence that this slowdown, or economic shrinking, has taken hold. Rates of employment are still extraordinarily high and economies appear to be still growing, especially in the United States.
If we are to be at the peak of the interest rate cycle, something has to give. This has been a largely pain-free process so far; either the Banks have conjured up the softest of feather bed landings, or else there is a degree of unpleasantness in the pipeline. This is the intended consequence. It is also the context in which we should see the slowly increasing number of corporate profit warnings. Last week’s notable leader was Apple, where a 7% fall in the stock price resulted in sizeable drops in both the S&P 500 and Nasdaq indices. In the marbled hallways of the Banks, Apple’s struggles will be seen as a good thing, with the hope and expectation that there will be more to come.
This is the quid pro quo for equity markets. For this to be the peak of the rate cycle, there has to be more corporate pain than we have seen thus far. There will be more profit-warnings and markets will become more volatile. Last Friday, the US non-farm payrolls rose by 187,000, the smallest gain in the year to date. It is also likely that this number is an overestimation. Investors and markets are always obsessed by the daily noise and headlines, frequently to the expense of reality. What we see with the monthly games of charades around the US employment data ignores the subsequent and under-played revisions. In the previous six months, the headline monthly releases have averaged 311,000. The later revisions to these have lowered this by a rough 41,000, or total of 245,000 jobs. The last two months have also shown a sharp decrease in hiring, which obviously implies that business is slowing.
The current noise from the Banks is that, even though they may have stopped raising rates, we need to get used to them being where they are. Swallow your cod liver oil and stop moaning, it’s for your own good. As we seem to be arguing each week, markets will have to wrestle with the conflicting pulls of the harm already done by the massive rises in the costs of borrowing, with the hope that this will soon be lowered. It is a volatile recipe.
This week we have the monthly updates to the inflation rates in China and the United States. The former is struggling to prevent a slip into deflation. The latter may well see the first rise in the headline rate since last June. It will be interesting to see how that is received.
Finally, congratulations to those who knew the lines from The Backstabbers and Babylon Sisters. Today, one to help forget July: “Hey you with the pretty face, welcome to the human race”. And a very brief Steely Dan: “Your everlasting summer”.
Jim Wood-Smith – Market Commentator and Head of Climate Transition
All charts and data sourced from FactSet
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