Goldilocks under threat?

In the last newsletter, we pointed out that „the context at the beginning of the year is favourable for the markets, both equity and bonds, as it incorporates quite a favourable mix: continued disinflation, the prospect of an upcoming pause by the Fed and the expectation of a vigorous recovery in China following the end of the zero Covid strategy. In short, a Goldilocks-like outlook. At the beginning of the year, it is always tempting to extrapolate recent trends. Experience shows, however, that intra-annual developments are rarely linear. It is thus likely that economists will revise their inflation forecasts downwards and that the statistics for the coming months, fuelled by the Chinese recovery, will be more disappointing.”

The January US inflation numbers that were released on 14 February have rather reinforced our idea that the Fed’s monetary tightening will be a little stronger and a little longer than what was still anticipated by the markets at the beginning of the year. Not that the disinflation process is in question. But it will be more complicated than expected.

Let’s not forget that the slowdown in US inflation is mainly due to the downward trend in energy and goods prices (almost 37% of the index) over the past few months, thanks to lower commodity prices, the easing of supply chains and the manufacturing recession. Underlying inflation in services excluding rents (which accounts for almost 25% of the CPI) remains fairly robust (4% annualized over three months). It is unlikely to decelerate without a clearer easing in the labour market.

However, the slowdown in the labour market is still largely insufficient. It is true that wage pressures are easing. Hourly wage growth fell to 4.4% in January from 4.8% in December and 5% the previous month. The same can be said for the cost of employment. On an annualized basis, it was up 4% in Q4 2022 vs. 5.8% in early 2022. In short, we are in the 4/4.5% zone. But we are still far from Powell’s comfort zone, which is more like 3/3.5.

And it is not the 517 000 jobs created in January (according to the Establishment Survey), three times more than the consensus forecast and twice as many as in the previous month, that will allow us to anticipate a more marked easing of the labour market.

In short, investors had somewhat forgotten that the Fed’s last press release of 1 February had mentioned that „the Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time”. In his press conference, Powell reminded the audience that Fed members were more concerned about doing too little than too much in the fight against inflation. He also mentioned that the shift to 25bp rate hikes did not mean that the pause was near.

Of course, there are no hard and fast rules and monetary policy is more of an art than a science. But it seems to us that the Fed’s pause will probably be pushed back to June (with a terminal rate at 5.50% and not 4.90% as the Futures were predicting earlier this year). Since the beginning of February, the markets have revised the terminal rate upwards, setting it at 5.35% for the Fed at the time of writing. Hence the tensions on the equity market and, above all, on the bond market since the beginning of the month. Beyond that, what can we infer from recent trends?

  • Long-term interest rates will fall less quickly and/or sharply than expected in H1, resulting in slightly less favourable bond performance
  • Real long rates will rise a little more than expected in H1 (which will penalize gold and growth stocks a little)
  • The dollar will be a little more resilient in H1 (especially against the euro)
  • The reversal of the slope will deepen somewhat in the coming weeks
  • Risk-adjusted performance will be a little less favourable for emerging assets in the coming weeks.