Global equities continued their impressive rebound over the past week, helped by dovish news from several central banks which in turn lowered bond yields. The S&P 500 rose 2% over the week, with U.S. 10-year bond yields dropping 10 basis points to 1.45%. The $US, meanwhile, held firm.
For starters, the Fed surprised no-one – formally announcing the commencement of bond tapering at US$15b per month. Equally important, Fed chair Powell reiterated his view that the current lift in inflation – although larger and more persistent than expected – was likely only transitory, reflecting a COVID-related surge in goods demand that supply chains have been unable to accommodate. U.S. equities also continued to bask in the warm afterglow of a red hot Q3 earnings reporting season.
The Bank of England did surprise, however, refusing to lift rates despite earlier hawkish signals and the market fully expecting a hike. Along with the European Central Bank and the Reserve Bank of Australia, what we’re seeing is a general push back from some central banks to the growing market view that the current lift in inflation means they will have to lift rates in 2022. Their message: not so fast! As I’ve long argued, many central banks – including our own – are being more guided by underlying labour market tightness and potential wage pressure, than likely short-run supply chain cost/price pressures.
Globally, the critical report next week will be the U.S. October consumer price index (CPI). Another modest gain of only 0.2% (2.4% annualised) is expected in the month, which would nonetheless push up the annual rate from 4.0% to 4.2%. Due to very low price increases earlier this year, annual core CPI inflation may well lift further in coming months, potentially reaching 4.5% by early 2022 if monthly gains remain around 0.2% over this period! That in turn could keep financial markets nervous about the inflation outlook, even though the supply-chain related surge in prices – from April to June – has likely already passed.
The bigger issue for U.S. interest rates is whether the millions of former U.S. workers return to the labour force as the economy re-opens, thereby easing current staffing shortages and wage pressure. If labour force participation remains low – suggesting many may have chosen early retirement – the economy will face capacity constraints more quickly in 2022, which in turn could have the Fed raising rates later next year. At this stage, my base case is that U.S. labour force participation will recover sufficiently to keep a lid on wage growth, allowing the Fed to delay raising interest rates until 2023.
Australian labour market report
The local equity market rode the global rally last week, and was also helped from some push back by the RBA. The S&P/ASX 200 rose 1.8% to be stuck in the 7,200-7,600 range of the past few months.
While the RBA did formally drop yield curve control – as I suggested last week – it reiterated that its base case remains for the first rate hike not to come until 2024. The 0.1% target on 3-year bonds (YCC) was dropped because the higher than expected Q3 CPI now means there’s some chance of a 2023 rate hike, though the RBA still thinks it will take a year longer before wages growth (now its key target) reaches over 3%. And contrary to current market expectations, the RBA still sees a rate hike next year as very unlikely.
In Australia, the major highlight next week will be the October employment report, which should provide the first evidence of an employment rebound following the lockdowns in New South Wales and Victoria. The market anticipates a 50k rebound in employment after 284k in job losses over September and August. I’m punting on an even bigger rebound of 85k. Reflecting a likely bounce back in the participation rate, however, the unemployment rate may actually rise from 4.6% to 4.7% .
*My usual charts and table could not be produced this week due to technical difficulties. They will be back next week!