More hiring than firing

• Chinese stocks continued to perform last week, boosting Asia and emerging market indices
• Oil rebounded, rising +8.4%
• The US dollar strengthened +1.9% versus sterling

• Japanese equities softened -3.8% in sterling terms
• Bonds declined across the UK, US and Europe

For weeks US data has been in focus as the market looks for clues as to the scope of interest rate tightening from the US Federal Reserve. Concern emerged over the summer that the labour market was decelerating rapidly, exacerbated by a weaker-than-expected July non-farm payroll report. Payrolls did recover in August, but July’s print was subsequently revised down further, undermining the more positive tone. However, September’s data surprised again with 254,000 new jobs added, up from 159,000 in August. The rest of the labour report was also sturdy – private payrolls almost doubled to 223,000 from 114,000, and earnings increased by 4% year-on-year, up from 3.9% in August. Survey-based measures echoed this positivity - the unemployment rate declined to 4.1% from 4.2%, with “underemployment” falling to 7.7% from 7.9%.

Broader data supports the view that the labour market remains relatively firm. Initial jobless claims spiked over the summer, exacerbated by severe weather and auto-plant shutdowns, but have since fallen back. The Job Openings and Labour Turnover Survey (JOLTS) also suggests the labour market is cooling gradually – openings and voluntary quits are now down 14% year-on-year, and hiring is down 10%. However, the pace of layoffs has not accelerated, and the ratio of vacancies to unemployed workers rose modestly in August.

All in all, this batch of stronger data has led market participants to re-evaluate their interest rate cut expectations. Following a jumbo -0.5% reduction in September, and despite push-back from Chair Powell and other FOMC (Federal Open Market Committee) members, futures markets were pricing in two or three rate cuts this year from the remaining two meetings, implying a further 50bps cut in December. In the wake of this stronger data, that expectation has been scaled back to two cuts, more in line with Fed guidance and our own expectations.

While cuts are likely to continue through 2025, given ample space for the Fed to reduce them before they become accommodative, pricing in 2025 and 2026 looks demanding, given the continued health of the US economy. Futures markets continue to imply rates troughing around 3%, at the lower end of estimates of the neutral rate of interest.

Sterling and UK assets had a wild ride last week after Bank of England  (BoE) Governor Bailey mentioned in an interview that the pace of UK rate cuts could be “a bit more aggressive” than was currently priced in. These comments came against a backdrop of a “higher for longer” narrative in the UK, given the improved outlook for consumption spending due to lower inflation, and continued worries in some quarters of the  Monetary Policy Committee (MPC) as to the possible persistence of services inflation. Sterling fell over 1% against the dollar on the day, though the movement in rates markets was more muted. The market continues to price-in a rate cut in November or December, with a second by February.

Bailey’s comments appear at odds with the MPC guidance in September which confirmed that “In the absence of material developments, a gradual approach to removing policy restraint remains appropriate.”

Looking at the data, there is continued evidence of housing sentiment continuing to improve. Money and credit data showed net mortgage lending continuing to creep higher to £2.9bn, while mortgage approvals edged up to 64,900 in August. In contrast, UK GDP data for the second quarter was revised modestly lower to 0.5% from 0.6%, and to 0.7% in the first quarter. This takes the year-on-year growth rate to 0.7% from 0.9%, still above the potential growth rate, but softer than BoE forecasts. Growth is expected to moderate further from here, potentially hampered by greater tax drag following the October budget.

The renewed escalation of tensions in the Middle East put upward pressure on oil prices last week as concerns intensified around an interruption to Iranian supply – about 3% of global output. Oil prices are up 12% month-to-date (around $75 per barrel for Brent and WTI at the time of writing) reflecting the greater risk of disruption. However, prices remain modestly below levels seen in the summer, and over 35% below the peak experienced at the start of 2022. While a hit to Iranian output would impact global supply, OPEC+ countries (of which Iran is a member state) are currently looking to increase output, which would likely offset any crimp to global supply.

There appears to be little between conflagration or containment across multiple fronts in the Middle East. Recent events have arguably made a negotiated settlement more difficult. Lebanon’s now direct involvement puts Hezbollah in a political bind, while hostilities have boosted Israel’s ruling party’s ratings from a weak positon. A hawkish response in Gaza also helps keep the right of Israel’s parliament onside, while military bans on large gatherings may eliminate the risk of public protest.

 

 

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