Economic Woes Compound Sticky Inflation

The last month saw a raft of central bankers present to markets at the Jackson Hole Symposium, but the real market moves were on the back of disappointing economic data prints.

Though markets took Jackson Hole in its stride, it was, as ever, worth paying attention to. As is often the case, Jerome Powell garnered the most attention. He stuck to his recent rhetoric – reiterating that inflation is “too high” and that they’ll hike again if required and keep rates in restrictive territory until they are confident inflation is “moving sustainably down” toward their target of 2%. But what we did hear, and have been hearing more of, is balance and caution. The above commitments were caveated given the “cloudy” economic outlook, and as such the Fed will have to proceed carefully as they decide to “tighten further or hold rates and await further data”.

As it transpired this warning was well timed – recent US PMIs (an important forward-looking indicator) have made for poor reading, with manufacturing numbers showing persistent contraction and composite figures barely posting any growth. But the number which really spooked markets was the JOLTS job data – job openings fell to their lowest level since 2021 and fewer people quit their jobs, suggesting growing woes in labour markets.

The result was a shift lower in long terms rates and hike expectations – 2y treasury yields fell 15bps and market expectations for a hike in September halved to 10%. Markets now expect no more hikes from Powell & co. and the first cut to come as soon as Q1 2024, with rates coming down 120bps by the end of next year. Despite Powell’s warnings and the slight moderation in data, the speed of the cuts still feel a little exaggerated. There is still commitment to further hikes if required and if not keeping rates as is. To this end, now feels like an opportune time for those looking to hedge against higher rates in the coming year or two – this inverted curve means both cap prices and swaps are offering positive rates carry in the short term – that is, at-the-money rates are notably lower than current fixings.

Lagarde also spoke at Jackson Hole, like Powell she stated that “inflation remains undefeated” but wouldn’t commit one way or the other to action at the upcoming meeting. And like the US, but worse, data out of Europe has been worrying – PMIs came out very poor, with Germany in particular producing some of the worst figures since the early Covid days of 2020. These figures were made worse on Thursday with inflation numbers remaining stubbornly above 5% - bringing to life the central bank’s worst nightmare of failing economic growth and inflation refusing to moderate.

Many of those same challenges continue (and continue to grow) in the UK – PMIs point to persistent contraction, core inflation remains at almost 7%, and finally the cracks are beginning to show in housing.

With the US arguably faring the best out of a bad bunch, the fact that it is the only curve with aggressive cuts priced in over the next year continues to look unusual and supports our view that the most pressing risk in the US is a reversal of this curve inversion.