Key Takeaways
- November was a good month for equity and bond markets.
- Many investors now expect the Federal Reserve to start cutting rates next Spring.
- US unemployment figures are out later this week – we’ll be keeping a close eye on the data. Will the Sahm rule be triggered?
- With inflation easing rapidly, interest rate cuts in Europe could well match those expected in the US.
- Inflation is falling more slowly in the UK however, so the Bank of England could keep rates higher for longer.
November was a great month for financial markets with rallies in both bonds and equities. It began with a dovish meeting of the Federal Reserve on 1st Nov which referred to tighter financial conditions. Equities and bonds both fell in October and the 30-year mortgage rate reached 7.5%. This led the market to speculate on deeper and earlier rate cuts in 2024 than previously. The moves in financial conditions were all reversed and more in November yet there was no push back from the many Fed speakers last week. Markets are now pricing in over 1% of rate cuts in the US next year, starting as early as the spring.
It’s a similar story in the Eurozone where markets were delighted to see a big drop in inflation last week. Rate cuts are expected to match those in the US. The UK is something of an exception which we discuss later in the article.
But for now, leading central banks are firmly on hold. With unemployment low and inflation falling but still above target, that is the obvious policy. The trigger for a cut in the US is most likely to be a rise in unemployment.
US Unemployment Rate % of labour force
The chart shows that US unemployment has always risen in recessions over the last 50 years. That’s hardly surprising. But in 2019 Claudia Sahm, an economist at the St Louis Federal Reserve discovered that even a small rise in unemployment of just 0.5% indicates a recession months before the committee of economists that determines US recessions make their call. US unemployment is currently 3.9% and has already risen by 0.5% from its low but the rule requires it to do that on a 3-month moving average. If the figures released this Friday edge up to 4.0% expect talk of recession to become very loud indeed. If it stays at 4.0% for another two months, the Sahm rule will be triggered. But will it be triggered? It’s a close race between labour supply, boosted mainly by immigration and demand for workers which is still positive as the economy continues to grow.
It’s always possible that US inflation keeps falling and the Fed can cut rates without a rise in unemployment and without a recession. But a rise in unemployment would make them act earlier and go further.
There is no equivalent to the Sahm rule in the UK and our official statistics on the labour market are in a mess. Nonetheless, although inflation is falling in UK, it is clearly lagging behind in the disinflation race. The Bank of England may well be forced to keep rates higher for longer. I still think we get big cuts in UK rates in 2024 but not as quickly as I previously thought.
