It has been a week in which financial markets have been driven by the economic data
With better-than-expected US inflation data helping the market mood and lifting equities and bonds. The casualty has been the US dollar, which weakened to a 14-month low as investors reassessed the outlook for US rates against other developed markets, many of which appear further behind in getting to grips with inflation.
The economic data has been dominated by news from the US, with the June employment and inflation reports published. The US employment report came in beneath expectations for the first time in over a year, with Non-Farm payrolls increasing by 209,000 in June, and revisions of -110,000 to the prior data. While the headline number failed to meet expectations, this was still a solid employment report, with hours worked increasing over May, and wage growth climbing to 4.4% year on year. The unemployment rate fell back to 3.6%. The dampening of the payrolls data is consistent with a decelerating labour market but one that remains reasonably healthy. There remain 1.6 jobs available for every unemployed person in the US, a ratio that has dipped slightly since 2022 but remains well above pre-pandemic levels.
The US economy has added 4 million jobs since 2020, despite the labour market turbulence during the pandemic, and the lack of workers on the sidelines has been a strong driver of wage growth, an issue we are also seeing in the UK – more on that shortly. The inflation data in the US was better than expected, helping both bonds and equities rally on hopes that the Fed will not need to go much further hiking rates as inflation approaches their target range and boosting expectations that we will see multiple rate cuts next year. CPI for June was up 3.0% year on year, down from 4.0% in May, while core CPI, which excludes food and energy, was up 4.8%, down from 5.3% in May. Both headline and core CPI were lower than expected – this raises the spectre of the Fed hike that is fully priced in for later this month being the final hike of this cycle. The Fed will likely want to see more evidence of a sustained fall in inflation but this data point was certainly very encouraging and supported by PPI data, a strong leading indicator for inflation, rising just 0.1% year on year.
We were reminded again of the weak momentum in the Chinese economy with inflation data for June showing no change year on year. Core inflation eased to 0.4%, while PPI data fell further into negative territory, down 5.4% year on year – the weakest pace since 2015. The underwhelming data from China of late continues to drive expectations of larger scale stimulus measures from the authorities to counter the sluggish and unbalanced reopening from the Covid pandemic.
The latest UK employment report showed the unemployment rate climbing from 3.9% to 4.0% but the main headlines were around the growth in wages, where average weekly earnings, ex bonuses, were up 7.3% year on year in the three months to the end of May. Speaking at the Mansion House in the City of London, both Bank of England Governor Andrew Bailey and Chancellor Jeremy Hunt called for wage restraint, arguing that high pay settlements were hitting the fight against inflation. Bailey noted the “unexpected resilience” of the UK economy had exacerbated wage and demand pressures, contributing to “sticky” inflation.
The Chancellor said that both he and Andrew Bailey would do “what is necessary for as long as necessary to tackle inflation” and return CPI to the 2% target. Bailey said that “nobody wanted to see unemployment higher or growth weaker, but price and wage increases at current levels are not consistent with the inflation target”. Market expectations for UK rates continue to climb, boosting sterling but leaving mortgage rates at their highest level since 2008, with the average 2-year fixed mortgage now at 6.66%. According to Bloomberg data, the terminal rate for UK rates next Spring currently sits at 6.31% with another aggressive 50 basis point hike seen as probable when the Monetary Policy Committee convenes in early August.
The NATO summit in Lithuania this week has dominated the political news flow. The summit appears to have been a success in that we have seen Turkey agree to support Sweden joining the military alliance, and enough positive noises made to keep Ukraine on track to eventually joining the alliance. NATO Secretary General Jens Stoltenberg hailed the defence plans agreed at the summit as the “most comprehensive since the Cold War”. These encompass a shift in military capabilities towards the border with Russia, and take into account the significant increase of the NATO border with Russia now that Finland has joined the alliance. Ukrainian President Zelensky met with NATO leaders on Wednesday and said he has “faith” that Ukraine will be allowed to join the alliance though there is clearly a level of frustration over the lack of a timeline to accession.
The NATO communique stated that Ukraine had made “substantial progress” enacting democratic and military reforms and the waiving of part of the accession process meant that Ukraine can join NATO swiftly “when allies agree, and conditions are met”. One of those conditions is likely to be the end of the conflict, so this is not imminent, though the support for Ukraine from NATO continues unabated for now. That said, the spectre of a future Donald Trump administration taking a different stance will be something for other NATO members to ponder over the coming months. Trump previously claimed that if elected, he would “end the war in 24 hours”; he also previously threatened to go as far as leaving NATO. The US accounts for two thirds of total NATO military spending, and while progress has been made, only 10 of the 30 NATO member nations currently meet the defence spending target of 2% of GDP. Hence a NATO with reduced US commitment would be a severely weakened alliance.
A reminder that Scott and I hosted a webinar yesterday covering year to date performance for the portfolios and wider assets, and focussing on how the Artificial Intelligence theme has turbocharged some US stocks so far this year. We also discussed our recent decision to add to Japanese equities and some of the portfolio changes we have made during the second quarter. You can listen to the replay here.
Have a good weekend,
Regards,
Anthony.
