15 August 2023: Near term outlook remains sluggish

From the mid-seventies to the mid-eighties’ redundancy became a significant factor of working life as more firms rationalized their workforce to deal with the slowing economy.

It is possible that the same effect is taking place now, with the number of redundancies growing larger month-by-month as firms first reconsider their investment plans and then abandon them altogether.

While it was sensible to “stockpile” workers given the cost of rehiring them if the economy rapidly recovered, given the wage demands and shortage of both skilled and unskilled workers, today’s employment report for July could deliver the first definitive evidence of the effect that the long-running cycle of rate hikes is having on the economy.

The claimant count has been on an upwards trajectory over the past few months, and that is expected to continue, while wage increases may be levelling off.

The data that has been released over the current quarter has not really demonstrated any significant slowdown, but the seventy-five basis points of hikes at the past two meetings of the MPC may see tighter monetary policy begin to bite.

With inflation predicted to have fallen by more than one per cent in July, when the data is released tomorrow, the conditions may be present for the MPC to consider a pause in the chain of hikes when it next meets.

While the economy remained in positive territory in the second quarter, the outlook remains sluggish, with growth barely registering. The month-on-month data has been distorted by the extra Bank Holiday granted for the Coronation and the exceptional weather that was seen in June.

With those factors removed, the current quarter may provide a more genuine reading of current conditions.

With inflation to continue to fall but not reach the Bank of England’s 2% target until 2025, the Treasury will expect the Bank To pull back on hikes quite soon to allow the economy to begin to grow closer to the trend. Rates are now considered to be restrictive on demand, and history shows that they will only stay at that level for a single quarter before causing severe damage to the economy.

Sterling fell to its lowest level since early July yesterday in thin markets, which magnified the move. It reached a low of 1.2616 but recovered to close at 1.2683. The data released over the next two days will determine its path until the Bank Holiday which takes place in less than two weeks.

Although headline inflation rose marginally in July, the pressure remains for the FOMC to agree to another pause in rate hikes when it meets again next month. It is probable that inflation will have fallen further, reversing July’s increase and more.

While several of his colleagues have made oblique comments that speak to the intention to vote for a pause, the Chairman of the Fed Jerome Powell, is believed to favour further tightening.

He is understood to believe that if the economy is considered sufficiently robust to “handle” a further hike, the committee should continue to push back against inflation to bring it back to target as soon as possible.

This would provide the Fed with more flexibility to begin to cut rates earlier when it becomes necessary without the need to concern itself with causing inflation to spike.

Rates are neutral but close to restrictive at their current level. The evidence is seen in the gentle fall in job creation. Powell believes that once they are hiked to a genuinely restrictive level, inflation will return close to 2%.

That has been the goal since the cycle of hikes began, and this is not the time to take the “foot off the brake”.

This timing of any Fed switch to more expansive monetary policy will be considered ideal by the Administration, with the Presidential Election Campaign to be in full swing by the time rates are cut.

It will be particularly galling for the Republican Party to see one of their “card-carrying” members driving an improvement in the economy.

Joe Biden spoke controversially about how he believes that the slowdown being seen in the Chinese economy is a “ticking bomb” for the U.S. The two countries are at odds politically and ideologically but rely on each other as they are the only ones who can drive growth in the other’s economy.

Biden said that “when folks have bad problems, they do bad things”. A clear warning to China over its threats to Taiwan, a country that America has vowed to protect.

The dollar index has now put several layers of support between it and the 100 level as it continues to recover from its significant correction earlier in the year. There are now very few “legacy” long positions, and once the market sees greater volatility and liquidity, the Greenback is well set to make more gains.

Yesterday it rose to a high of 103.46 but ran out of “oxygen” and fell back to close at 103.16.

In the continued search for stories to print while Eurozone policymakers are on holiday, market analysts have turned intentions to the possibility that the ECB may be driven by German public opinion when it decides whether to pause its cycle of interest rates in September.

There is no such thing as a decision-making European Central Bank. It is no more than a convenient title for the collective decision-making of the twenty member states.

It has a greater responsibility for regulation of the individual markets of the European Union, and the banks that operate within them. It is true that Christine Lagarde has been far more proactive than her predecessors as President of the Central Bank.

That is because she has a more diplomatic and political background than Duisenberg, Trichet, or Draghi, who were considered technocrats who reacted to the situation before them rather than trying to influence the issues.

The rest of the Frugal Five will be swayed by Germany’s stance over a further rate increase since Germany’s economy is in a dire position, and neither the Chancellor nor the President of the Bundesbank has yet spoken of how they feel the ECB should act.

Olaf Scholz is secure in his role and is under no pressure from the country despite the economy being in recession 147k more people are unemployed than a year ago. While this is significant, it is far from getting out of hand. The employment minister commented recently that the demand for labour is currently restrained.

The more significant issue facing Germany is the influx of immigrants from outside the EU that has fuelled sporadic incidents, but so far, they have been controlled.

Today’s release of the ZEW index for Germany is expected to show some marginal improvement over recent months, but there will still be concern over future prospects.

The Euro fell to a low of 1.0874 yesterday, but there is some good buying interest from corporate accounts, which saw it rise to close at 1.0905.

Have a great day!