Given the steep losses many investors have experienced in recent weeks, many want to identify the culprit that is responsible. Two have emerged. Federal Reserve Chair Powell and Russian President Putin. Putin’s threat may have encouraged some risk adjustment, but looking back at February 2014, when Russia invaded Crimea and annexed it, it should not be exaggerated. If anything, the S&P 500, for example, may have gained a little, depending on the exact dates one uses.
The same is for the Swiss franc against the euro. The franc rose to six-year highs against the euro last week. In 2014, when the SNB was capping the franc (floor for euro at CHF1.20), there did not seem to be much pressure on the cross. In fact, domestic sight deposits, which offers insight into intervention, fell from mid-February 2014 through mid-March. Gold rallied about 5% from February 23 invasion to March 17. It gave it all back plus more by the end of the month.
It is easy to blame the Fed for the stock market sell-off, after all, many claimed it was responsible for lifting valuations to such extreme levels in the first place. Yet, it is a bit more complicated than simply the Fed is going to tighten to sell stocks. Indeed, the data presented by MarketWatch’s Mark DeCambre shows that more often than not, the S&P 500 rallies over the course of most Fed tightening cycles.
On the other hand, to twist a phrase from Orson Welles, if you want an unhappy story, you must know where to end it. Goldman Sach’s (GS) Chief US equity strategist David Kostin who was quoted on Yahoo Finance notes that on average in recent cycles, the S&P 500 sells off 6% in the three months after the first Fed hike and then recovers almost fully in the next three months.
With the volatility of equity markets and the risk of conflict in Europe, risk is sucking up oxygen. Three events – central bank meetings, the eurozone’s December CPI, and US jobs will dominate the agenda. Of note, China’s markets are closed for the entire week, and before the markets re-open, the Beijing Winter Olympics will begin (opening ceremonies February 4) amid a flare-up of Covid cases.
Central Bank Meetings
1. Reserve Bank of Australia: The market has been pressing that the RBA needs to hike rates considerably sooner than Governor Lowe has allowed. The central bank’s forward guidance is for a rate hike late next year or early 2024. The market has not thought this was a reasonable stance for some time. Consider that with a 10 bp cash rate, the one-year swap first rose above 80 bp at the end of last October. It was still near there on January 10, and last week sustained a move above 120 bp. By January 25, when Australia reported higher-than-expected Q4 CPI (3.5% year-over-year, up from 3.0% in Q3 and above the Bloomberg median of 3.2%), the swaps market had made its move. The central bank emphasizes the underlying rates (trimmed and weighted medians), which are at eight-year highs. The RBA will likely begin capitulating at this meeting. It may begin with an upgrade of its labor market and price outlook. The RBA could announce the end of its bond buying after. It will leave some room to allow a hike this year. This may translate to a hawkish hold for the RBA, but it still would not have caught up to the market. The $0.7000 area is technically a critical area. At the very least, it frayed ahead of the weekend. That said, the non-commercials (speculators) in the futures market have only trimmed their record net short Aussie position by a little bit through Tuesday, January 25.
2. Bank of England: After a stutter last November, the Bank of England hiked the base rate 15 bp in mid-December 0.25%. With inflation rising, and rising faster than expected, and robust job growth and a 4.1% unemployment rate (3.8%-3.9% in 2019), there is little reason not to expect another rate hike this week. The swaps market has priced in no less than a 75% chance in recent weeks. The swaps market has 100 bp of tightening discounted for this year. Governor Bailey indicated that when the base rate rises to 0.50%, which will be this week with a quarter-point hike, the BOE will begin allowing its balance sheet to shrink by not rolling over the maturing proceeds. There is a large maturity in March. In addition to the two-pronged monetary tightening, the UK economy is being asked to withstand a strong bout of fiscal tightening. Consider that the budget deficit is expected to fall to 3.9% this year after a little more than 8% last year (median forecast in Bloomberg’s survey). Political pressure remains on Prime Minister Johnson. Assuming he would not resign, a leadership challenge is the other path. However, ahead of the May local elections, this may be too bitter of a pill for the Tories to swallow, abandoning the impish prime minister that delivered Brexit as such and led the party to regain its parliamentary majority.
3. European Central Bank: In contrast to the Bank of England, there is little for the ECB to say or do. The strategy through Q1 is in place and there is no urgent need to alter course. And this is doubly true without new staff forecasts. The spring wage round is important, and the market expects the ECB to likely move later this year. The swaps market is pricing in 20 bp higher rates over the next 12 months, and back zero by the end of 2023. The preliminary estimate for January CPI will be published the day before the ECB meets. Traditionally, that is before Covid, prices would often fall in January. Last year was the first time in more than a decade that prices did not fall. It is expected to have reverted back to form, and the median forecast (Bloomberg) is for a 0.5% decline in the month-over-month measure, which would bring year-over-rate down toward 4.5% from 5%. The core rate is seen at 1.8%, down from 2.6%. The German VAT is a key factor. It contributed to the upside and now the downside. The hawks may feel a little restrained, though they remain less convinced than President Lagarde that the price pressures will subside with Covid and the repair of supply chains. The ECB’s Chief Economist Lane provided a blueprint of the central bank’s logic. He said that if the goal is inflation around 2%, and conceding 1% productivity growth, wages to achieve inflation target. What follows from that is wage growth must average more than 3% for the ECB to hike. Portugal goes to the polls on January 30 but will likely stick largely to what they have. The French presidential election is not until April, but Macron’s declining support may keep it in the news.
4. EM: Two emerging market central bank meetings are notable. Brazil’s central bank meets on February 2. It has already signaled another 150 bp hike that would lift the Selic rate to 10.75%. It would be the third hike of this size beginning last October, and it followed two 100 bp increases in Q3 21 and three 75 bp moves in H1 21. With last week’s IPCA inflation CPI showing its second consecutive slowing (to 10.2% after peaking at 10.73% last November), investors seem to be getting more concerned about growth. The IMF’s latest forecasts warn growth will slow to 0.3% this year from a little less than 5% in 2021. Several bank economists are talking about contraction. One important takeaway is that rates are near a peak.
The Czech central bank meets on February 3. The question is not if but how much rates are increased. The central bank has hiked at every meeting starting last June and is not done. The policy rate (two-week repo) is at 3.75%. It was at 0.25% as of last May. The market seems divided between a 25 and 50 bp move. Inflation jumped to 6.6% in December, but the base effect is favorable for a substantial drop in January. Recall that in January 2021, CPI surged 1.3% on the month. Hungary (7.4% December CPI year-over-year) has been very aggressive, and its one-week deposit rate has been ratcheted from 0.90% in July 2021 to 4.3% last week. Poland (central bank meets on February 8) has become more aggressive after lagging the other two. Its reference rate was at 0.10% as recently as last September. It has been hiked four months in a row to stand at 2.25%.
Last week’s Bank of Canada and FOMC meeting may dampen the market’s reaction function to the January employment reports. The jobs data are often important because of what it reveals about the economy and the impact on policy. As labor slacked gets absorbed in both countries, slower job growth should be expected, but the vagaries around the Covid disruptions and faulty seasonal factors may inject more volatility into the data.
In fact, US non-farm payroll growth has slowed. The average monthly gain was 365k in Q4, the lowest quarterly average of 2021. After an increase of 199k in December, non-farm payrolls are expected to rise by a little more than 200k, helping 35-40k increase in government jobs. Recall in 2019 that US jobs rose by nearly 170k on average a month, and in 2018, the average was almost 195k. The unemployment rate is derived from the household survey, and it is expected to be unchanged at 3.9%.
The average work week may have ticked up, and it could be related to the Covid-related absenteeism. Recall that in January 2021, the average work week spiked to 35 hours. Yes, 35 hours, the highest in many years since at least before the Great Financial Crisis. The average workweek was 34.7 hours in H2 21.
One element that may cause some consternation average hourly earnings are likely to continue to accelerate through at least the first part of this year. The median forecast in Bloomberg’s survey calls for a 0.5% increase, which matches the monthly average for H2 21. Yet, due to the base effect, it will be sufficient to lift the year-over-year rate back above 5%. At 5.2%, it would match last year’s quickest pace. It is possible that the earnings data overtakes the modest jobs growth as the key to the market’s reaction.
The Bank of Canada passed on its first opportunity of the year to hike rates last week but left no doubt that the cycle will begin at its next meeting in March. It noted that the output gap had closed. Almost regardless of specifics of the January jobs report, the Bank will not be deterred. Consider that full-time positions grew by an average of almost 95k in H2 22. Adjusting for the relative populations, it would be as if the US created a million jobs a month. In 2018 and 2019, full-time jobs grew at an average monthly pace of about 18k and 25k, respectively.
Canada has also done a better job of integrating more of its population into the labor market than the US. On the eve of the pandemic, the participation rate in Canada averaged 65.5%. In the US, it was closer to 63.2%. At the end of last year, the Canadian participation rate had almost completely recovered to stand at 65.4%. In the US, it has reached 61.9% in November and remained there is December.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.