17 August 2022: Unemployment rate unchanged

GBP – Pay rises more than twice the Government’s inflation target

The biggest takeaway from yesterday’s publication of the employment report for July was the fall in real wages. Despite wages rising by 4.7%, up from 4.4% in June, real wages fell by more than 3%. This is the largest gap between prices and wages since records began more than twenty years ago.

The effect of rising inflation will be felt further in the coming weeks with more strikes planned by railway workers who will be joined by the postal union who plan two strikes before the end of the month.

The plans suggested by the Leader of the Labour Party – to scrap the rise in the energy cap and freeze it at its current level for six months – have been rejected by both Conservative Party leadership candidates.

Both Liz Truss and Rishi Sunak claim that such a short-term fix would be both costly and counterproductive.

Truss favours an increase in the green levy on energy bills, and increase in domestic gas production, while Sunak defended his decision to increase national insurance contributions despite the funds raised having had no visible effect on NHS waiting times.

Both candidates acknowledge that the conflict in Ukraine is likely to continue for a longer time than any analyst had predicted when it began in March. This will be a significant contributor to both headline inflation and global growth until well into the first quarter of 2023.

In a rare sign of unity, Truss confirmed that, if elected, she would want Sunak in her Cabinet. Sunak did not reciprocate this offer.

Inflation data is due for release this morning. There is a possibility that headline price increases that include volatile items like food and energy will see its first fall in several months. However, this is unlikely to be sufficient to deter the Bank of England from raising interest rates again at the next meeting of the Monetary Policy Committee.

Despite a possible fall in the headline, core inflation could reach 6%. The core includes recent pay awards which are beginning to feed through into inflation.

The rate of inflation is not expected to fall materially until next Spring. As employers are forced to award pay increases at or close to the rate of inflation, such deals may begin to be part of the issue.

The pound is feeling the pressure for a stronger dollar and may fall below the 1.20 level if the market begins to believe that the Bank of England may turn a little more dovish as its most vehement critic of rising inflation, Michael Saunders, leaves the MPC.

Yesterday, it managed to claw its way above 1.21, reaching 1.2117, but fell back to close at 1.2094.

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USD – Volatility to grow across financial markets on Fed uncertainty

The CEOs of several major Wall Street Banks are predicting a significant rise in market volatility over the next two quarters as the Federal Reserve continues to tighten monetary policy despite the threat of a real recession.

J.P. Morgan recently published its results for Q2, and its net revenue was down 28% driven in the main by a prudent addition of $428 million in provision for bad loans. Despite making the provision, its CEO noted that overall, its customer’s balance sheets were in a strong position which does not currently point to a recession.

However, the slowdown in China, the conflict in Ukraine, the potential for a global energy crisis and further tightening of monetary policy all point to an increase in volatility.

Bank of America’s Head of Economics also chipped in with a similar view. He expects a mild recession to begin before the end of the year, although he still predicts a soft(ish) landing.

Michael Gapen believes that the number of factors outside the Fed’s control make their job that much more difficult, but navigating a path through a moderate downturn should be possible.

One major leading indicator for the economy, the NY Fed’s Empire State Manufacturing index, turned much lower this month, falling from a reading of 11 in July to -31.3. This was far worse than expected, as the market was expecting a far less severe fall.

Building permits and more particularly housing starts both fell according to data released yesterday. As mentioned before, these statistics are seen as the first sign that tighter monetary policy is having an effect.

Fed Chairman Jerome Powell may be facing something of a crisis of business confidence over the next couple of months. He is adamant that inflation should remain the Central bank’s focus, despite the threat that its actions could bring about a genuine recession. Just what that would look like remains unclear.

With a couple of weeks remaining until Labour Day, the traditional end of summer in the country, the markets are unlikely to find any reason to end their current malaise.

The dollar index remains in a tight range, with traders unwilling to commit themselves prior to any change in Fed Policy. Yesterday, it attempted to climb above the 107 level but ran into selling pressure, making a high of 106.94 before settling back to close at 106.46.

EUR – Tools to help most indebted still under review

Yesterday saw the publication of one of the most significant indicators of business and investment confidence for Germany and the wider Eurozone, and it did not make pleasant reading for the ECB.

The Munich-based research institute ZEW sees the current situation in Germany at -47.6, down from -45.8 in July, while economic sentiment also fell, from -53.8 to -55.3. It was a similar story for the Eurozone, with economic sentiment also falling, from 51.1 to 54.9.

The region is also suffering from an increase in the size of its trade deficit. Seasonally adjusted, the deficit rose from Eur 27.2 billion to Eur 30.8 billion. This is mostly due to the increased cost of energy imports, despite their actual volume having fallen.

It appears that every day there is further evidence of a significant slowdown in economic activity which is denting the confidence of business, investors, and consumers alike.

The German Energy Ministry issued a report this week in which it said that the country must reduce its use of energy, gas, by 20% to avoid having to introduce rationing this winter.

Despite the dire economic outlook for the region, money markets are pricing a certain increase of fifty basis points at the next meeting of the Central bank’s Governing Council.

There is a remote chance that the increase could be seventy-five basis points, although that could be seen as counter-productive, since it would hasten the probable use of the Bank’s new tools designed to limit the gap in spread between benchmark German Government bonds and those of more heavily indebted Eurozone members.

Germany appears to have taken back the reins of the entire economy, having allowed itself to be outmanoeuvred and outvoted over both the level and tenor of the period of support provided during the pandemic.

Even with inflation at more than four times the Bank’s target, the fact that the less financially disciplined states are accepting of higher interest rates is testament to the willpower of the Bundesbank and the Central banks of the rest of the frugal five.

The euro is still attracting buyers on any approach towards 1.01 versus the dollar. Yesterday, it fell to a low of 1.0122, but recovered to close at 1.0171.