Last week was a quietish one for markets. Global equities inched up 0.2% in local currency terms, although gained 0.9% in sterling terms as the pound retreated against a stronger dollar. As for bonds, it was a mixed story. US Treasuries ended the week flat while UK Gilts posted a gain of 1.0% on the back of a decline in yields.
The main event on the macro front was the US employment data on Friday which came in stronger than expected. Payrolls posted another robust gain in November, albeit partly inflated by workers returning following the end of the auto strike. The unemployment rate also saw an unexpected decline, falling to 3.7%.
Meanwhile, wage growth was unchanged at 4.0%. This is well down on the high of 5-6% seen a year or two ago but still higher than is consistent with inflation returning to the Fed’s 2% target level.
These signs that the labour market continues to hold up surprisingly well dented a little the market’s newfound confidence that a sizeable reduction in rates is in the offing next year. That said, the market has merely pushed back its date for the first rate cut from March to May and still sees rates falling 1% by the end of next year.
This conviction will be tested by the Fed meeting on Wednesday. This is certain to leave rates unchanged. Rather, all the attention will be on the Fed’s new set of forecasts and how robustly Chair Jay Powell pours cold water on the market’s hopes for rate cuts.
The ECB meeting on Thursday will be a similar story. There should be no change in rates with the focus on to what extent President Christine Lagarde endorses the market’s assumption that rates will be falling by March and be 1.5% lower by year-end. The market’s belief is based on the sharp fall in inflation seen in recent months and a stagnating economy.
Thursday also sees the BOE meet and once again policy is certain to be kept unchanged. Here, however, there is less uncertainty about the forthcoming guidance and a bit less market optimism on how fast rates can be cut. BOE officials have in recent weeks reiterated that there is no scope for cuts any time soon and markets are pricing in rates starting to fall in June with a 0.5% cut by year end.
The relatively hawkish stance of the BOE is primarily down to the stickiness of inflation which remains significantly higher than in the US or Eurozone. But it also in part reflects the unexpected resilience of the economy which has been corroborated by the latest housing numbers. The Halifax and Nationwide indices have both shown house prices rising in the last two or three months and down only a modest 1-2% on a year earlier.
Market attention is not just focused on the Fed, ECB and BOE but also the Bank of Japan which meets next Tuesday. Here the big question is how quickly it abandons its super easy policy. It has already taken a few steps in this direction but recent comments by bank officials have fuelled uncertainty as to the timing of the next move. This is important both because of its implications for the yen and because the BOJ has until now been a source of downward pressure on bond yields globally.
While markets overall take their lead from the big beasts in the central banking world, country performance is also very dependent on the action of the domestic central bank. And for emerging market equities, rate cuts are becoming an increasing support with policy easing front-running that in the developed world. In Brazil, for example, rates started to be reduced back in August and this week should see the fourth consecutive 0.5% reduction.
All said and done, it’s all in the hands of the central bankers as to whether the Santa rally in markets continues or falters in the run-up to Christmas.
Rupert Thompson – Chief Economist