23 January 2024: Retail sales data brings a recession into focus

There is considerable confusion in the market about the current state of the UK economy.

Late last week, speculation was beginning about the possibility that the country could achieve a soft landing with considerable progress having been made in bringing down inflation, while the most recent employment data showed that the unemployment rate still is steady at around 4%.

Now, fears about a recession are growing following a fall in the level of retail sales in December.

It seems that the major political parties are magnifying every piece of economic data to make the story fit their agenda, as the battle to win the General Election has begun in earnest.

There is a third player in this game of 3D chess, and that is the financial market analysts and commentators who are trying to sort the “wheat from the chaff” and disseminate what is genuine news and what is electoral propaganda.

To “stir the pot” even further, in his latest interview, the Chancellor, Jeremy Hunt, a man destined to play a significant role in the entire “soap opera”, gave yet another hint about tax cuts in his Spring Budget that is now just six weeks away from being delivered to Parliament. However, he also underlined the work that is still to be done by acknowledging that the economy may already be in a technical recession.

Hunt took his lead from the economists at the EY Item Club, a leading group of forecasters.

After a minimal contraction of 0.1% between July and September, the economy may well have also lost ground in the last quarter, achieving the basis for a technical recession.

Hunt will want to place the data from last year firmly in the rearview mirror as he concentrates on looking forward to better times ahead.

The fall in retail sales may prepare the ground for the first in what is likely to be a series of rate cuts by the Bank of England, although the first is unlikely to be agreed at the next Monetary Policy Committee meeting, which is scheduled to take place next week.

The EY Club acknowledges that the economy is on an upward path. They estimate that growth of between 0.7% and 0.9% is likely to be achieved this year.

While that is below the average of the last decade if the “Covid years” are disregarded, Hunt and Rishi Sunak will likely want to concentrate on looking forward in the coming months.

Members of the MPC have been conspicuous by their absence from the newswires over the past few weeks, although it is unlikely that the individual base cases of the independent members have changed radically, while the permanent members will continue to take their lead from Andrew Bailey.

The market, meanwhile, perfectly illustrates the state of flux in which the pound currently finds itself. The number of conflicting data points and opinions has seen it remain in a relatively narrow range since the turn of the year.

Yesterday was a little different, with Sterling rising to a high of 1.2733 and closing at 1.2708. Within the confines of its current range, it has performed solidly, making fresh highs, and closing the past five sessions higher.

There is expected to be “lively debate” at next week’s FOMC meeting regarding the timing of the first rate cut following the hiatus that has been seen since it first paused and then announced that the cycle of rate hikes had ended.

It seemed that as soon as the announcement was made that the cycle of hikes had ended, speculation began about when the cuts would begin.

Jerome Powell has been firm in his comments since then that rates will need to remain elevated for a considerable time to both bring inflation down and allow the economy time to adjust to the “secondary effect” of rate hikes that are already “in the system”.

The lack of any specific period for the current hiatus has brought the Fed some time, but the speculation is starting again.

Very few, if any, observers are looking for a cut in rates at next week’s meeting, given that inflation, both core and headline, rose in December.

There will, however, be a growing level of anticipation that Powell will acknowledge that rate cuts were at least discussed. He will not feel comfortable setting an agenda, while he has the relative luxury of being able to be data-driven.

The market will have to wait until February 21st when the minutes of next week’s meeting are published to gauge the view of the entire committee, although there are sure to be comments from the “usual suspects” about their views on when cuts should begin.

This week’s release of preliminary output data for January is unlikely to shift the view of the market. This is the one set of data that has been reinforcing calls for rate cuts to begin.

Both manufacturing and services PMIs are expected to remain below the 50 level, which denotes a contraction.

One piece of long-term data that has been used to stoke fears of a recession in 2024 has begun to show some renewed positivity.

The Conference Board Leading Indicator Index, which along with the inversion of the yield curve, is seen as a precursor of an economic downturn, fell by just 0.1% in December, far less than had been expected.

Despite the overall fall, six of the ten leading indicators are now in positive territory. Furthermore, the decline in the other four has slowed significantly.

The dollar index is still treading water as the geopolitical situation is offset by the view that the FOMC may announce a timetable for rate cuts soon.

Last night’s bombing of Houthi positions inside Yemen by U.S. and UK planes has not, yet, seen any increase in risk aversion, which would likely provide a boost to the dollar.

Yesterday, the index rose marginally to a high of 103.37 and closed at 103.34.

A survey of ECB staff has found that in the view of more than fifty per cent of participants, Christine Lagarde has performed badly, or in some cases, very badly in recent years.

The findings of the survey point to considerable internal dissent, driven in no small measure by concerns over pay and conditions.

This will be seen as a major setback for Lagarde who is just over halfway through her fixed eight-year term. Lagarde’s approval rating has fallen well behind that of her predecessor, Mario Draghi, and is now even lower than that of Jean-Claude Trichet, who preceded Draghi.

It is felt that her external activities are not focussed on the core business of the ECB.

She is said to concentrate too heavily on politics, which both betrays her background and is feared to be in preparation for her next assignment.

Overall, not being a trained economist, which her predecessors were, means that she relies too heavily on the views of her colleagues and is unable to form her own, independent, opinions.

Although the survey didn’t highlight it, it also appears that she is allowing too much latitude for members of the Governing Council to express their opinions about monetary policy, which leads to a feeling of fundamental disagreement.

The employment market in the Eurozone is still exhibiting a curious degree of strength that does not appear to follow the level of interest rates that are believed to be and have been for some time, at a level which is restricting demand.

It is believed that that is one reason Robert Holzmann spoke recently of his view that it may not be possible for rates to be cut this year.

While this is a minority view, the first quarter employment report, which is expected to be published in May, is being viewed as a possible catalyst for rate cuts to begin.

While the more dovish Central Bank Governors may well vote for cuts to begin at this week’s rate-setting meeting, they will be outvoted, unless there is a sea-change in the attitude of the more moderate but influential Governors from the likes of The Netherlands, Belgium and most importantly, France.

The euro is still supported by a market view that rate cuts are still some way off, even though the economy is possibly already in recession.

It fell marginally yesterday but remains in a narrow range. It reached a low of 1.0880 and closed at 1.0884.

Have a great day!