Both the markets and the central banks are signaling a shift in economic risks from inflation to growth. The focus is primarily on the slowdown in the US labor market, the weakening global manufacturing sector, the risk of deflation in China and the difficulties in the eurozone to sustainably overcome the stagnation phase. Although the share indices have recovered from the slump at the beginning of August, the downside risks remain. This can also be seen in the falling trend in government bond yields and the trade-weighted US dollar.
Slowdown in the US labor market
Every February, the employment estimates from the current employment statistics (CES or Current Employment Statistics) are compared with comprehensive employment counts for the month of March (benchmark revisions). The preliminary data for this were published last week. Normally, the estimates are plus / minus 0.1 percent. For this year, the preliminary benchmark revision for total non-farm payroll employment shows an adjustment for the month of March of minus 818 thousand or minus 0.5%. Spread over twelve months, the revision implies a monthly growth in employment that is around 70 thousand lower.
The unemployment rate in the USA is still fixed. The release of August labor market data on September 6th will be an important event for the markets. © unsplash
Overall, the labor market in the USA is still firm. The unemployment rate for July is at a low 4.3%. However, it has already risen from 3.4% in January 2023. This is worrying for statistically based recession indicators such as the Sahm rule. In the past a moderate increase has often been followed by a sharp rise. The latter would mean a recession. The publication of the labor market data for August on 6 September will be an important event for the markets. The key question is: “Continued moderate slowdown or will the labor market break?”
Economic-friendly (dovish) central bank signals
Central banks in the developed economies are reacting to changes in the economic environment (falling inflation, increasing growth risks) by easing their interest rate policy.
According to the minutes of the US Federal Reserve’s meeting on July 31, the overwhelming majority took the view that an easing of monetary policy was likely at the next meeting (September 18) if the data continued to be roughly in line with expectations. This was followed by a disappointingly weak labor market report and a mild inflation report.
The central banks in the USA and the Eurozone are focusing their monetary policy on growth and no longer so much on inflation. © Angela Weiss / AFP / picturedesk.com
Last Friday, Fed Chairman Powell said in his opening speech that the time had come to adjust monetary policy. His confidence in a sustained fall in inflation back to two percent has grown. The data on inflation and the labor market show a changing situation. The upside risks for inflation have diminished. And the downside risks for employment have increased. Powell was cautious about the pace (depending on the data). However, there were implicit indications: “A further slowdown in the labor market is neither desirable nor welcome.” This means that the interest rate is to be lowered to a neutral level. The Fed’s long-term estimate is 2.8%.
In Sweden, the central bank (Riksbank) cut the key interest rate for the second time this year last week (currently: 3.5%). They raised the possible further rate cuts (to three to four) in its forward guidance. For the eurozone, the minutes of the ECB meeting show that the September meeting was seen as a good time to reassess the scope of monetary policy restrictions. A further key interest rate cut has already been fully priced in for September 12. (Interest rate for the deposit facility from 3.75% to 3.5%). The market is even on track to price in a total of three key interest rate cuts by the end of the year (currently: minus 0.7 percentage points).
According to ECB minutes, the persistence of inflation in the services sector remains the most important element determining the inflation outlook. Inflation rates are indeed on a downward trend (consumer price index in July: 2.6% year-on-year, core inflation: 2.9%), but inflation in the services sector remains high (4.0%). In this context, the decline in negotiated wages from 4.7% year-on-year in the first quarter to 3.6% in the second quarter provides encouraging indications of a decline in overall wage price increases (compensation per employee) and thus also for inflation in the services sector. However, the indicator (Negotiated Wages) should be treated with caution as it shows some weaknesses.
Weak manufacturing sector, weak eurozone
The preliminary purchasing managers’ indices for the month of August for key developed economies suggest a continuation of the slightly below-average growth path (resilience). The overall view of the reports across sectors (manufacturing, services) and countries or regions is consistent with inflation-adjusted GDP growth of around 1.3%. The decline in the overall figure in the USA is striking. While the figure in the other countries and regions (eurozone, UK, Japan, Australia) has risen.
However, the indications of regional convergence remain weak overall. At 54.1, the USA still has the highest figure. At the lower end of the spectrum is the eurozone at 51.2. Within the eurozone, Germany is once again well below the eurozone value of 48.5, with a decline even being recorded in August. The increased sectoral difference is particularly negative. While the Purchasing Managers’ Index for the service sector has risen (54.1), that for the manufacturing sector has fallen further (47.4). The decline in the employment component to slightly below the neutral value (49.9 vs. 50) is also noteworthy.
Soft landing with downside risks
Overall, the latest economic data confirms the basic scenario of a “soft landing with downside risks”. On the positive side, inflation is falling again after the surprising increases at the beginning of the year. This makes it easier for central banks to respond to the increasing growth risks with easing measures. We currently remain defensively positioned in our tactical asset allocation. The underweight in equities versus bonds and gold remains for the time being.
Note: Forecasts are not a reliable indicator of future performance.
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Legal note:
Prognoses are no reliable indicator for future performance.