lower inflation

Is the labour market turning? It is not at all clear The labour market is also remaining remarkably (and unhelpfully) firm, with May data showing an unexpected rise in full-time employment and a drop in the unemployment rate. Viewed against long-run trends, the unemployment rate remains extremely low and doesn't seem consistent with slower inflation. And then there is wage growth, which is also still heading higher, though is very lagging, so we don’t really know what is going on here in real time.    So, despite the slowdown in overall economic growth, there are a number of indicators that still look like reasons for more tightening, rather than either easing or pauses, though we suspect these are not yet showing the full extent of the effects of earlier monetary easing.     Also, the RBA has at times seemed keen not to overtighten given the lags involved in the monetary transmission mechanism. Time is likely to be a helpful ally for rate doves allowing the slowdown to work through the economy more fully. This is certainly true of the lagging labour market.  What happens in other central banks, most notably the US Federal Reserve may also play a role. It will be far easier for the RBA to hold fire if that is also what the Fed is doing. Though this also remains a tight call and the current guidance from the Fed is for another 50bp of tightening, even though we don't think that they will ultimately deliver.    All things considered, the case for believing that the cash rate may have already peaked is weakening, if not entirely dead. So while this remains the base forecast, it will not take much for us to jettison it in favour of further hikes. That said, the market expectation for a further 50bp of tightening does feel too high, and we would limit any further increase to 25bp. It would certainly help our current call a lot if activity and labour data both swung our way in the coming months, to bolster the message from lower inflation, on which we feel a much stronger conviction. We have, however, ditched our view that rates will be cut as soon as 4Q23, and have pushed this out into 2024.   AUD/USD outlook

BoE decides after another bad inflation report.     Federal Reserve (Fed) Chair Powell didn't say anything we didn't know, or we wouldn't expect in the first day of his semiannual testimony before the American lawmakers yesterday. He said that the Fed will continue hiking rates, but because they are getting closer to the destination, it's normal to slow down the pace. He repeated that two more hikes are a good guess, and that the economy will suffer a period of tight credit conditions, below-average growth, and higher unemployment to return to lower inflation.   The US 2-year yield pushed higher. The 10-year yield was flat given that higher short term yields point at higher recession odds for the long term. The gap between the 2 and the 10-year yield is again at 100bp.  In equities, the S&P500 gave back some field, but not all sectors suffered. Tech stocks pulled the index lower, financials and real estate were down, but energy stocks led gains as US crude jumped past $72pb on news that the US inventories dipped by around 1.2 mio barrel last week. Industrial, materials and utilities were up, as well, as a sign that a rotation toward the laggards could be happening rather than a broad-based moody selloff.  In currencies, the US dollar fell and is now testing the April-to-date ascending base - not because the Fed's Powell sounded more dovish, but because what's happening beyond the US borders makes the Fed look more dovish than what it really is.     By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank

Prioritise quality companies. If an investor needs to take a defensive stance, it is worth turning to quality stocks, as their robust balance sheets and stable cash flows should insulate them from unforeseen downside risk. With this in mind, many of the largest technology and Internet stocks meet these criteria, while exposure to highly cyclical sectors and companies with excessive leverage should be kept to a minimum. Thus, in order to increase the resilience of your portfolios, you should focus on high quality companies, strong dividend payers and also not forget about regional diversification, as lower valuations and a weaker US dollar can also make global stock markets outside the US attractive.   The general understanding is that the market is likely to come out of the correction this year with expectations of a continued recovery in the second half of the year and a return to a bullish trend. This recovery is expected to help recoup portfolio losses from 2022.   However, there are several factors that pose risks to the market in the near future. These risks include the potential for a bear market, which could be triggered by inflation statistics such as the PCE index and strong labour market conditions. Another risk is the narrow scope of the current rally, where only some sectors have shown growth while others, including cyclical, defensive and growth sectors and assets such as bonds, have remained weak. There is also uncertainty about the timing and severity of a possible recession this year. The market is now looking at the likelihood of a moderate recession, which is already factored into current expectations and prices.   Once there is more clarity on these risk factors, portfolio allocation can be adjusted accordingly, considering both bonds and stocks, with a focus on the second half of the year and recovery of losses incurred in 2022. Two scenarios were considered for such an adjustment:   Scenario No. 1, the positive outlook, sees the market rising and breaking through significant resistance levels of 4200-4300 in the SPX index, which would lead to a rally. In this case, it would be prudent to increase long positions. Risky stocks should be held until they reach the most likely level of local recovery, and then locked in. For positions that still have potential, they should be held. The portfolio as a whole should then be rebalanced, creating a new balanced structure with a 25% allocation to cyclical assets, 35% to growth assets, 10% to protection and 30% to bonds.   Scenario #2, the negative outlook, assumes that the market continues to decline either from the current level or below 4100. In this scenario, protection should be strengthened by using inverse ETFs and reducing long positions (using stop losses) until the target stock is reached. This approach aims to minimise further drawdown until the correction is finally resolved in 2023.   The US stock market has thus experienced a strong recovery since the start of the new year, supported by a resilient technology sector, growth in the semiconductor industry due to AI development, a strong Q1 2023 reporting season, a pause in the Federal Reserve's rate hike, expectations of future rate cuts, lower inflation, a resilient economy, a smooth economic landing and a debt limit increase. While risks are still present, a focus on longer-term investment strategies can help investors benefit from the market's upward trajectory and continued recovery in 2H.  

CEE: Disinflation continues across Central and Eastern Europe, opening up the possibility of central bank rate cuts. However, lower inflation does not necessarily mean faster rate cuts. The local story will increasingly create divergence across the region.   Commodities: We have revised lower our oil forecasts for the latter part of the year. A more hawkish Federal Reserve, limited speculative appetite (given the uncertain outlook), robust Russian supply and rising Iranian supply all suggest that the market will not trade as high as initially expected.   FX: The dollar downtrend is "on hold" as markets await key data to determine the new peak for Fed rates and the timing of rate cuts. EUR/USD may trade around or slightly below 1.10 in the third quarter as the US data story fails to turn clearly USDnegative, but medium-term undervaluation and a forecasted drop in US short-term rates suggest a climb to 1.15-1.18 in 4Q23/1Q24 remains possible.   Rates: Market rates are feeling the pressure. Risk assets have been bought into, and inflation is not calming fast enough. Central banks are piling further pressure on them. The US 10yr Treasury yield won't look right until it hits 4% and can take out the prior high. The 10yr Bund yield should get back to 2.75%, at least, and can still look up, possibly to about 3%.

Bank of England survey raises hope of lower inflation The Bank of England survey of corporate pricing plans contains good news, but June's 50 basis-point rate hike shows that policymakers are losing patience and confidence in these forward-looking inflation indicators. Expect at least two more 25bp hikes, but better news on inflation should allow a pause later this year.   Some good news on inflation for once If you’re looking for some good news on the UK inflation story, then on the face of it there’s plenty of it in the latest Decision Maker Panel from the Bank of England. This survey, which historically policymakers have paid close attention to, asks chief financial officers (CFOs) a variety of questions about their expectations. And for several months now, it has pointed to more muted price pressure from the corporate sector. Here are a few of the stand-out figures: Expected price growth over the next year is 4.9%, down from a peak of 6.6% a year ago (and 5.9% in April). Wage growth is seen at 5.3% over the next year, having peaked at 6.3% in December. The proportion of firms finding it “much harder” to recruit compared to normal is at 29%, comfortably the lowest it has been since the question was introduced in October 2021. It was typically between 50-60% through much of 2021/22. One-year ahead CPI expectations are at 5.7%, down from a peak of 9.5% seen last September, though three-year expectations nudged up slightly. All of this echoes what we’ve seen in some of the other leading indicators of inflation, including producer price inflation which has come down dramatically over recent months. The doves at the Bank of England would argue that all of this suggests inflation should come down dramatically later this year, and the recent stickiness is simply a longer-than-expected lag time from lower input price inflation.   Recruitment difficulties are easing

If there’s a sliver of good news for policymakers, it’s that there are further signs that the UK’s worker shortage crisis is becoming less acute. The number of people inactive (neither employed nor actively seeking a job) has continued to fall. Where at one point there were more than half a million extra people inactive compared to pre-pandemic, that figure now sits at 173,000. That’s overwhelmingly because of a net influx of students to the jobs market, helping to offset elevated long-term sickness levels which haven’t improved at all. That, and a marked increase in economic migration this year, has helped lower the proportion of companies reporting that it is “much harder” to recruit in recent Bank of England surveys of Chief Financial Officers (CFOs). The latest jobs figures also contain further signs that the labour market is cooling, though it’s a gradual story. The unemployment rate ticked up to 4% in May, albeit the redundancy rate has barely budged over recent months. The reality though, as the Bank of England’s rate June decision made clear, is that these trends have been on display for several months now, and policymakers are losing confidence that they will translate into lower inflation. The BoE is focused squarely on the official pay and CPI data as it emerges.   Worker shortages have eased, but it varies by sector   The downside to that strategy of course is that wage growth is one of the most backward-looking indicators out there. And we think we should see pay pressure start to ease later this year – how quickly is up for debate. Bank of England modelling indicates that higher inflation expectations among consumers/businesses explain most of the previous rise in wage growth, and by that logic you’d expect pay pressures to abate a fair bit from here on. Consumers, and to a lesser extent businesses, are no longer expecting such aggressive price rises over the coming months. But as we discussed in more detail last month, we think that modelling underplays the role of worker shortages. In the UK jobs market – where only a minority of roles are linked to collective bargaining agreements/formal pay negotiations – it’s ultimately the ability (or threat) of workers quitting that keeps pay growth elevated. Higher inflation may incentivise workers to switch jobs more readily than they might otherwise, but the process relies on a strong underlying jobs market. Our tweaked version of that BoE modelling finds that post-pandemic shortages were a big driver of the wage pressure we’re seeing now. While those worker shortages are easing, the story varies considerably across sectors and at least some of these hiring challenges can be explained by structural rather than cyclical forces. Persistent staff shortages suggest the downtrend in wage growth, when it comes, is likely to be pretty gradual.

Moderate outlook From a sectoral point of view, the strength of demand for tourism-related activities and the high level of bookings for this summer should support French economic activity in the third quarter, but the support should diminish thereafter. At the same time, the industrial sector is suffering from weakening global demand. According to survey results, business leaders' assessment of order books has remained very weak for several months. At the same time, inventories of finished products remain high. This means that production is likely to decline over the coming months, as companies see no new orders coming in and have to clear their inventories. The PMI indices for the manufacturing sector have been in contraction territory (below 50) since January. In short, the growth outlook for the French economy is moderate. Growth in the second quarter will be weak, with a fall in GDP remaining a risk. Growth in the third quarter should be slightly better, supported by the good health of the tourism sector, which continues to benefit greatly from the post-pandemic recovery. But this is likely to lose momentum in the fourth quarter, and the end of 2023 and 2024 look weaker, against the backdrop of a global economic slowdown and high interest rates that will have an increasing impact on demand. We are expecting growth of around 0.5% this year. For 2024, the gradual recovery in household purchasing power thanks to lower inflation is likely to be offset by even weaker global demand. As a result, we are less optimistic than the central banks and are forecasting French GDP growth of 0.6% in 2024 (compared with a forecast of 1% by the Banque de France).     The trend toward disinflation has begun and will continue Inflation in France stood at 4.3% in June, compared with 5.1% in May, thanks to a fall in energy prices and slower growth in food prices. The fall in inflation is set to continue over the coming months. Growth in producer price indices has slowed markedly. In addition, business price intentions are moderating sharply: price intentions in the manufacturing sector are at their lowest since early 2021, while in the services sector they are at their lowest since November 2021. These figures are in addition to those for the prices of agricultural products, which are falling sharply, which should lead to a sharp fall in food inflation over the coming months. The trend toward disinflation is therefore clearly underway and will continue. However, this trend will probably be slower in France than in other countries, due to less favourable base effects for energy. The tariff shield and fuel rebates prevented a sharp rise in energy prices over the summer and autumn of 2022. As a result, energy inflation is likely to return to positive territory in France in the coming months, with energy prices for the remainder of 2023 likely to remain higher than their levels in 2022, unlike in other countries. This will probably keep overall inflation higher in France than elsewhere this autumn and at the end of 2023. But this does not change the overall picture: ultimately, although less visible than elsewhere, disinflation is well underway and will continue to be seen in France over the coming months. While this trend is clearly encouraging, it does not mean that the problem of inflation is completely over. There is still a major risk pocket, namely services inflation, which is likely to increase in the months ahead and will probably become the main contributor to French inflation by the end of the year. The successive increases in the minimum wage, particularly in January and May 2023, which are being passed on to all wages, will continue to push up the price of services. The Banque de France estimates that negotiated pay rises will average 4.4% in 2023 (compared with 2.8% in 2022 and 1.4% in 2021), often supplemented by a one-off bonus. Salary increases are more pronounced in sectors where recruitment difficulties are greatest. As we expect the labour market to remain tight over the coming quarters despite the economic slowdown, wage increases are likely to strengthen further. However, given the lower price intentions and sluggish demand we expect in the coming quarters, it is likely that wage increases will not be fully passed on to selling prices, weighing on margins. Therefore, inflationary pressures, including in the services sector, should eventually subside. We expect CPI inflation to average 4.6% in 2023 (5.6% for the harmonised index) and 2.1% in 2024 (3.1% for the harmonised index).   The French economy in a nutshell (%YoY)  

Recent range highs broken after CPI release Lower inflation could increase gold’s appeal One more rate hike expected from the Fed   The US inflation data gave gold just the boost it needed to break back above $1,940 after failing to pierce that level in recent days. The yellow metal has been range-bound in recent weeks between $1,900 and $1,940 and today’s report did what the jobs data failed to do; it provided the catalyst for a breakout.     There remains plenty of resistance ahead for gold and today’s move doesn’t necessarily suggest the correction we’ve seen since May is over but it’s a massive step in the right direction. If the inflation data continues to improve then that could be bullish for gold. The next tests for gold are $1,940, $1,960, and $2,000, which roughly represent the 38.2%, 50%, and 61.8% Fibonacci retracement levels from the May high to the June lows. The inflation data may have come too late to change the outcome of the July Fed meeting, especially in light of the June jobs report, but it may alter the central bank’s language if it does hike by another 25 basis points. It’s going to be a big summer of data.