It was another challenging week for global markets, not helped by a higher than expected U.S. inflation report and a concession by Fed chair Powell that he might not be able to stop the economy tumbling into recession. China’s harsh yet seemingly futile efforts to contain COVID via lockdowns is also unnerving sentiment, as are ongoing energy and food disruptions caused by the entrenched war in Ukraine.
Despite a net loss for the week, however, Wall Street saw fit to rally on Friday if only because the market appears deeply oversold in the short term. Indeed, what was notable last week was that although equities dropped further, bond yields also eased – which I suspect reflects investor attention starting to focus on the risks of a growth slowdown as the Fed funds rate inexorably heads higher in coming months.
Don’t be fooled – Wall Street has far from priced in the risk of a recession, with earnings expectations still holding up and price-to-earnings valuations only back to around their average of recent years. If the U.S. does tumble into a recession later this year or next, the peak-to-trough decline in the S&P 500 is likely to be deeper than the near-20% decline seen to date – I’d expect a fall of at least 35%.
As regards the U.S. April CPI report, although annual inflation did ease back – and has likely peaked – the monthly increases remain uncomfortably high. Excluding food and energy prices, for example, the core CPI rose by 0.6% in April (market was expecting a 0.4% increase). What’s more, while goods price inflation is easing (such as for used cars) as demand switches back towards services as the economy re-opens, this in turn is generating service sector price pressures (like airline prices) due to the backlog of pent-up demand.
In a surprisingly candid interview, moreover, Fed chair Powell noted that while his base case is that higher interest rates can contain inflation without causing a recession (as the intention is to cut excess demand without shrinking actual supply), the task won’t be easy – especially given ongoing global supply disruptions. And if push comes to shove, Powell conceded that getting inflation under control remains his top current priority – even at the risk of a Volker-style recession similar to that of the early 1980s.
Powell speaks again this week and his candid views might get more airplay. There’s also a focus on activity data this week, with U.S. retail sales, housing starts and existing homes sales. If there’s a reason for oversold markets to continue to recover – in at least the short term – it could be because of tentative signs emerging of slowing growth, which in turn could limit the degree of further bond yield increases. Last Friday’s further slump in U.S. consumer sentiment is a nod in that direction.
Bad news (i.e. weaker economic growth) could be good news again – provided it does not weaken too dramatically!
Local economic data was mixed last week, with the NAB business survey revealing still fairly upbeat business conditions even as the Westpac consumer confidence survey showed households increasingly unnerved by the lift in inflation and interest rates and the softening outlook for house prices. So far at least – as is the case in the United States – reduced consumer confidence has not translated into weaker consumer spending, with local Q1 retail sales volumes rising by a solid 1.2% after surging 7.9% in Q4.
The impact of China’s lockdowns on iron-ore prices together with the strong $US saw the $A weaken further last week, hitting my long-held target of US 68c (albeit briefly!). This is also another potential sign that investors are starting to think about the downside to economic growth rather than the upside to commodity prices and interest rates.
China’s monthly ‘data dump’ is out today, which is likely to reveal weakness in industrial production and retail spending – hardly positive for iron-ore prices or the $A.
Two key local highlights this week will be Wednesday’s (once all-important) Q1 wage price index report along with Thursday’s April labour market report. Wages growth is expect to continue the gradual acceleration seen in recent quarters, with a gain of 0.8% expected (after 0.7% and 0.6% in Q4 and Q3 of 2021 respectively) – which will take annual wage growth to a still relatively low 2.5% (from 2.3%). Of course, given all the anecdotal reports of labour shortages and rising wage pressures, it would not be surprising if the WPI is a lot higher than expected (say even +1%) which would only affirm the RBA’s intention to lift interest rates by around 0.4% in June, taking the cash rate to 0.75%.
Thursday’s labour market report, meanwhile, should show a further solid gain in employment (to the extent employers could find available workers) and a drop in the unemployment rate to a multi-decade low of 3.9%.
Have a great week!