Financial Update from Brewin Dolphin - 13 January 2023

January 2023

The Weekly Round-up

Friday 13 January 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses the latest US inflation figures and the start of the corporate earnings season.

Last week was a busy start to the year with the release of some crucial data that supports our view of the economy. As a reminder, the key takeaways were:

- The US labour market remains tight. The unemployment rate dropped to an all-time low in December, a healthy number of new jobs were filled, and yet job openings remain high as well.
- Underlying inflationary pressures remain modest. In the US wage inflation slowed despite the tight labour market, while in Europe early estimates of December’s inflation were surprisingly low.
- Economic sentiment is very fragile. The real curve ball came from a very sharp decline in the ISM non-manufacturing index at the end of last week. Most notably, the new business series fell very sharply

Meaning that more respondents saw their new business decline than rise during December (the numbers are seasonally adjusted).

So what more have we learnt this week? The most telling and anticipated release was the US consumer price index (CPI) report. For most of 2022 this had huge importance, enduring a run of record upwards surprises and, at times, shocking the markets. More recently, its importance has ebbed a little. The last few months have been softer and, as discussed, the release was pre-empted by lower inflation figures from Europe.

When it landed the numbers were in line with expectations. So what did we learn?

Inflation moderates

Headline inflation slowed, reflecting weakness in volatile energy prices. This alone will not sway many policymakers who naturally focus on more stable core inflation. Here, the annual rate of inflation slowed once more, but even the last few months remain at a pace that would be inconsistent with the Federal Reserve’s inflation target.

Nevertheless, the big picture is that inflationary pressure is moderating.

Digging into the details of the report, durables goods prices racked up their fourth straight month of declines. A reasonable drag on durable goods has been car prices. Car auction house Manheim has a used vehicle index that tends to lead the government’s CPI measure by a month. It has moved back into positive territory, which suggests there may not be this source of goods deflation in next month’s CPI report. Weakness in the dollar and supply chain issues in China may also push up prices. That said, consumer spending on durables has slowed after a massive surge in 2020/21 when consumers found solace in goods purchases as lockdown kept them from their usual services expenditure. Continued weak durables demand growth should ultimately continue to weigh on durable goods inflation.

Perhaps the most closely watched measure was the services ex-shelter prices. We have quite good visibility on shelter prices (mostly rents) which will eventually drop, reflecting current falls in house prices, so the remainder of the services category tends to be most sensitive to a tight labour market and wage inflation. Monthly services ex-shelter inflation picked up again last month after negative prints in October and November, so there were definitely aspects within the report that will keep the Federal Reserve on inflation watch.

Pressure remains

Aside from the CPI report, Thursday saw the weekly initial unemployment claims report continue to move lower, reiterating the tight labour market. A survey of small businesses earlier in the week had shown that a high percentage of firms still expect to have to increase worker compensation this year, even if those intending to increase staff numbers moderated a little. But despite that, the share of firms planning on increasing prices has been falling even faster than it rose last year.

So the available evidence continues to argue against the existence of a wage-price spiral and that will provide some qualified reassurance for policymakers.

Small businesses are still very cautious about the outlook, with more than half experiencing declining sales.

Earnings season

Although this week was quiet, next week will mark the first full week of earnings season. The coming weeks will be crucial in revealing the extent to which companies have been able to pass on higher prices and wage costs in order to protect profit margins. Investors are downbeat, with two thirds of respondents to a Bloomberg poll expecting that earnings season will drag shares lower. Despite the rise in markets since October, the fact that sentiment remains quite fragile is an encouraging sign.

The first really eye-catching companies to report are generally banks, with several reporting today. Although the results were mixed, with winners and losers among the Wall Street trading desks, most banks saw increasing provisions for credit losses. Lower income cohorts are beginning to find economic conditions difficult even though most consumers still have healthy cash balances. JP Morgan said it is preparing for a mild recession starting in the fourth quarter.

The UK reported an estimate of gross domestic product (GDP) growth during November which rose a mere 0.1% rather than declining as had been expected. Football-related hospitality spending was a contributor driven by the World Cup. It’s now in the balance whether the UK’s recession began in the last quarter of 2022. That will depend upon spending during a December that was dogged by snow and strikes. Regardless, the most difficult period is the first two quarters of this year, with cost-of-living grants being suspended in the first quarter. In the second quarter, taxes and utilities bills will rise, and around two thirds of mortgages are expected to require refinancing during 2023 at higher interest rates.

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