Financial Update from Brewin Dolphin - 8 December 2023

December 2023

The Weekly Round-up

Friday 8 December 2023

In her latest weekly round-up, Janet Mui, Head of Market Analysis, analyses the prospect of a ‘soft landing’ for the US economy, the cooling UK labour market, and the downgrading of China’s credit outlook.

Welcome to the first trading week of the last month of the year.

Broadly speaking, the markets saw a continuation of the theme in November; government bond yields declined and stocks rose. The enthusiasm for artificial intelligence (AI) remains a strong driver for the US equity market. It has been quite remarkable for gold prices to withstand higher real interest rates over the course of 2023. And as bond yields fell, gold prices reached a record high.

US jobs report leans on soft landing

The markets have already moved on from rate hikes to how many rate cuts we are going to see in 2024. The debate is whether rate cut expectations have gone too far. We got a sense check with the US non-farm payrolls report, this week’s elephant in the room in terms of data.

The US jobs report is hotter than expected, with a drop in the unemployment rate, a pick-up in monthly wage growth, and solid job creation in November. Labour participation also nudged up, which is positive from a supply and disinflation perspective.

While the general trend in US labour market data (including job openings and private sector surveys) shows a softening momentum, Friday’s report raises the prospect of achieving a “soft landing”, in which growth slows alongside lower inflation, the desired outcome of interest rate rises. Whichever way you look at the report, there is nothing alarming to suggest a recession will happen any time soon.

The solid data took a little steam out of the rally in bond markets, though it failed to dampen financial markets’ expectations of multiple rate cuts by the Federal Reserve next year. After the better-than-expected jobs report, the markets took away just half a rate cut that was priced in. The markets have already made up their mind on rate cuts and it will take quite a lot for those expectations to be challenged at this stage, when inflation is slowing down nicely and oil prices have fallen sharply. Well, the next challenge will be the Federal Reserve’s meeting next week where it will release the latest economic and interest rate projections.

More signs of the labour market cooling in the UK

The UK labour market is weakening, with the latest survey by the Recruitment and Employment Confederation (REC) and KPMG showing further evidence of the labour market loosening in November.

The survey highlights hiring of permanent staff contracted at the second-fastest pace since June 2020, whilst the supply of candidates for jobs jumped at the fastest pace since December 2020. Reduced demand for workers meant that starting salaries rose at the slowest pace in 32 months, while vacancies for permanent staff fell for the third month in a row. The higher supply of and lower demand for labour suggests the UK unemployment rate is likely to rise over the next six to 12 months and wage pressure may moderate. This is good from an inflation perspective but will continue to cast concerns on UK economic activity.

Though there is one good piece of news for the UK economy — expectations that the Bank of England has finished hiking rates and that rate cuts may happen in 2024 have resulted in the market reference rates for mortgages (swap rates) coming down notably. This is good news for homeowners who need to refinance and for prospective buyers. In fact, there is more evidence slowly declining borrowing costs have injected more optimism into the housing market. Two of UK’s biggest mortgage lenders, Halifax and Nationwide, have both reported unexpected increases in house prices this month. While higher interest rates reduce affordability and transactions, underpinning the resilience in home prices has been a shortage in supply.

Sayonara to Japan’s negative interest rates?

The big market moves this week happened in Japan, where the Bank of Japan (BOJ)’s governor and deputy governor both made comments that spurred speculation of an exit from its negative interest rate policy as soon as this month. The Japanese yen appreciated across major currencies (up over 2% vs USD) while Japanese stocks were down for two consecutive days after the speculation mounted. It is a reminder that the negative correlation of yen and Japanese stocks remains alive, particularly when yen moves are abrupt.

We have been of the view that normalisation of ultra loose policy in Japan is inevitable, though the degree and pace of change is likely to be modest.

There were concerns the development will end the last anchor of low rates and that higher Japanese government bond (JGB) yields will lead to higher developed markets bond yields. Market reaction suggests otherwise — the spike in yield is largely contained within the JGB market. The elephant in the room for bond yields remains the Fed and US macro developments.

Western central banks easing and the BOJ tightening in 2024 would be an interesting macro theme to watch. The fall in global bond yields probably provides a more favourable backdrop for the BOJ to normalise policy.

China credit outlook downgrade

The risks of persistently lower economic growth in the medium term and a downturn in the property sector led to concerns for China’s credit outlook. China is under pressure to support the economy and it has pledged a higher budget deficit. Authorities have offered more stimulus recently, including via the issuance of an additional one trillion yuan ($140 billion) worth of sovereign bonds to support infrastructure spending. China’s debt-to-GDP ratio is already over 280%, according to Bloomberg estimates. The developments prompted Moody’s to downgrade China’s credit outlook as it believes the efforts to support growth would further spur debt levels and ratios.

The Chinese government has already pushed back on Moody’s assessment, arguing that China’s economy is resilient and has large potential. The Chinese government is aware of the debt problem, that is why it is so far reluctant to unleash a large-scale spending spree. Despite the credit outlook downgrade, China will continue to support the economy as needed.

We saw such evidence at China’s latest Politburo meeting. Policymakers have called for a step up in fiscal support. To show signs of prudence and restraint, though, the authorities said monetary policy should be flexible, appropriate, targeted, and effective, with the previous wording, “forceful” dropped from the statement.

Similar to the developments in Japan, the impact of the event is largely contained within the Chinese domestic market. Hong Kong and mainland stocks were lower on the news, though China government bond yields and the Chinese yuan are little changed. The China credit outlook downgrade is unlikely to scare investors too much because foreign capital has already left the China sovereign bond market en masse.

Investors have been worrying about Chinese debt levels for a decade. Moody’s downgrade in the China credit outlook tells us what we already know, but it is a reminder of the issue of debt (addiction) relapse.

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