Financial markets appear to have started the year with a bit of a hangover, which us no surprise given the very festive mood in both equity and bond markets in the final two months of 2023
If it’s not too far into January to say it, ‘Happy New Year’. I might as well throw ‘Happy Easter’ into the mix, as Crème Eggs make a very welcome return to the supermarket shelves just in case you didn’t already overdose on chocolate over the Christmas period.
We have seen some of the strongest performing sectors from that period underperforming and bond markets seeing some jitters around expectations for when central banks, most notably the US Federal Reserve, will start to cut interest rates. The confidence in a March rate cut, which was priced with a 100% probability in Fed Funds Futures markets at the end of December, dipped as low as 50% last week, and currently sits at 63%. Such shifts in expectations have pushed bond yields higher, and driven underperformance in parts of the market, such as small cap stocks, that performed very well at the back end of 2023 on expectations of a looser monetary policy environment to come.
The Christmas period was thankfully very quiet for news flow but we have seen plenty of economic data to be dissected. The US reported another strong month of employment data, with Non-Farm Payrolls ahead of expectations. Payrolls increased by 216,000 in December. The unemployment rate was unchanged at 3.7%, not far above the cycle lows of 3.5% last March, though large numbers of people leaving the workforce – not exactly a positive signal – boosted the data. The leading indicator that is temporary hiring declined for the 11th consecutive month, another warning sign. US inflation for December ticked higher, at 3.4% year on year, driven by housing costs.
The UK saw growth data revised lower, to -0.1% in Q3 and to 0.0% in Q2. If the UK sees a negative final quarter of the year, then the definition of a technical recession will have been met It looks like being a close call. November’s GDP was up by 0.3% month on month, per data published this morning, this follows a 0.3% contraction in October. So, a decent month of growth is needed in December to avoid the UK being officially in recession. There was better news on UK inflation , which eased to 3.9% year on year in November, the slowest pace of price rises in two years. Core CPI, which excludes food and fuel, was 5.1%. Both figures were significantly better than expected.
The PMI and ISM data for December was a mixed bag. The general trend of 2023 was manufacturing weak and the services sector just about keeping the composite data above the line separating economic expansion from contraction. The eurozone was an exception, despite the services sector at its highest level in five months, the overall composite figure still pointed to contraction. The US services data fell sharply to a 7-month low, though it remained just about in expansion territory. The employment subcomponent pointed to job losses ahead, so will be watched closely to see if this was just a ‘blip’ or the start of a downtrend.
In terms of the central banks, the Bank of Japan meeting in the week before Christmas was a non-event, with interest rates held at -0.1% and no change to Yield Curve Control policy. The accompanying statement was dovish and gave no hints to tighter monetary policy, saying the Bank will “continue to maintain the stability of financing, and will not hesitate to take additional easing measures if necessary”. Governor Ueda reminded investors that, unlike other central banks, the Bank of Japan tends not to signal future policy moves, saying “there isn’t much chance of us suddenly announcing that we’ll raise rates a month in advance”. Ueda did however tell Japanese media that “it’s possible to make decisions if the bank doesn’t have the full results of spring wage negotiations”. The Bank continues to want to see sustained inflation and wage growth before they begin to normalise policy.
There have been no other major central bank meetings during the period, but the collective comments from US Federal Reserve members seems to have attracted more attention given their pushback on the prospects for rate cuts in the near term. Raphael Bostic of the Atlanta Federal Reserve said he only expects rate cuts to come in the third quarter. New York Fed President John Williams said the Fed “aren’t really talking about rate cuts” and it was “premature” to be thinking about a March cut. Their words were echoed by the minutes of the Fed’s December meeting which showed little in the way of a discussion on easing policy and noted that easing financial conditions could make it more difficult for the Fed to achieve their policy goals. The meeting minutes were certainly not as dovish as Fed Chair Jay Powell came across in the post meeting press conference. We will hear from plenty of Fed members over the coming weeks, with the end January meeting likely to give a clearer signal on what to expect in March, when a cut is still seen as probable in markets, if not the nailed-on certainty that Fed Funds futures were implying in late December.
Political news has been dominated by growing concern over the potential for the Israel-Hamas conflict broadening into a regional war with Hezbollah being dragged into the conflict from the Lebanese side while Iranian backed Houthis in Yemen attack shipping in the Red Sea. US Secretary of State Antony Blinken has been in the Middle East all this week trying to ensure no further escalation in the conflict. The attacks on shipping are already having consequences for supply chains as oil and container ships go the ‘long way round’ the southern tip of Africa, a slower and more expensive route, to avoid any security issues. The Financial Times reported the number of ships in the Red Sea heading to or from the Suez Canal is down 90% compared to the first week of 2023. There was a response last night from the US, UK and others in launching targeted attacks on Houthis in Yemen to, in President Biden’s words, “send a clear message that the US and our partners will not allow hostile attacks or hostile actors to imperial freedom of navigation in one of the world’s most critical commercial routes”. The BBC’s Frank Gardner writes very well on the challenges for the West in facing down the Houthis and the economics of taking out £16,000 drones with £1m+ missiles. See this link.
The focus next week will turn to US domestic politics as the Republican Primaries begin. The Iowa caucus should give some guidance on whether the other Republican candidates can get anywhere near to challenging Donald Trump. Trump’s biggest challenge may well be a legal one. With two states now having removed Trump (for now) from Primary ballots, it is clear the Supreme Court will have a significant role to play in this election, firstly in ruling on Trump’s eligibility to run in state ballots. The court will also most likely be asked to rule on some of Trump’s other legal issues. Trump will take some comfort in the fact he appointed three of the nine judges that make up the court, during his last term of office. We also need to keep an eye on the general election in Taiwan this weekend– a win for the incumbent DPP party, described as “separatists” by China, may well see a response from Beijing.
A reminder of some of the content recently published around our thoughts for 2024 – our webinar earlier this week covered this in some detail – you can find the replay here. In addition, the ’24 what if’s for 2024’ outlook can be found on our website here. Last but not least, the 24 minute long podcast discussing ’24 what if’s’ with TwentyFour Asset Management (who else ?!) can be found here.
Have a good weekend,
Kind regards,
Anthony.
