Did things just get better or worse?
Equity markets fell heavily this week. The falls are believed to stem from a change of investor views on where government bond yields are heading. The yield on the Benchmark 10 Year US Government Bond broke materially higher last Friday. This followed a strong US Employment Report and signs of wage growth, which in turn suggests wider inflationary pressures and higher global interest rates.
Hourly US wage growth rose to 2.9% year-on-year in January, the highest rate since 2009 and above the 2.7% increase expected. But this needs to be seen alongside a drop in recorded weekly hours worked, which suggests the jump in wage growth might be tempered over the coming months. In addition, other measures of wage growth show no rise, including the Atlanta Fed Wage Growth Tracker, which is an estimate of the wage growth of continuously employed workers. The market may have got a little ahead of itself, in terms of inflation expectations, especially when the deflationary forces of technology are taken into account.
Given we are seeing a period of broad synchronised global growth, fears of inflation and rising interest rates are not confined to the US. However, higher growth and inflation is not all bad news for equities. Higher sales volumes at higher prices support earnings. It is also the case that central banks are starting to tighten monetary policy gently from a very loose base, rather than slamming on the brakes. Indeed, it could be said that rather than the market pricing in materially higher future bond yields, the sell-off was also a healthy normal reset after a strong period of equity market gains, even if the speed of the move in bond yields over recent weeks has taken many by surprise. The market has been in a largely upward trajectory for two years, and some level of setback was overdue.
We should also note that incoming Federal Reserve Chairman, Jay Powell, may not wish to see interest rates rise aggressively and become known for bringing down the stock market so early in his term, especially given President Trump has made great virtue about recent equity market strength. Federal Reserve staff began formally warning about high asset values back in July last year, saying vulnerabilities associated with the gains had risen from “notable to elevated”, whilst also acknowledging that reforms have made the financial system far more resilient than they were in the 2007-2009 financial crisis.
Trump weighed in midweek, in his usual style, tweeting:
“In the ‘old days’ when good news was reported, the Stock Market would go up. Today, when good news is reported, the Stock Market goes down. Big mistake, and we have so much good (great) news about the economy!”.
Currently, however, markets are not following Trump’s script.
Here in the UK, the Bank of England’s quarterly Inflation Report and the minutes of Thursday’s Monetary Policy Committee (MPC) meeting added to concerns about inflation and the implications for monetary policy. The MPC agreed that over the forecast period monetary policy would need to be tightened somewhat earlier and by somewhat more than anticipated at the time of the November Report, adding that they were no longer willing to tolerate inflation above its 2% target for the next three years.
An eventful week!