Financial Update from Brewin Dolphin - 3 February 2023

February 2023

The Weekly Round-up

Friday 3 February 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses interest rate hikes by three of the world’s major central banks and a surge in US jobs growth.

This week saw the US Federal Reserve, Bank of England (BoE) and European Central Bank (ECB) make their first policy announcements of 2023, thereby setting the stage for the path of future rate hikes this year. As ever, the rate increases were widely expected by financial markets and so it was the subsequent press briefings that garnered the most attention.

Fed announces smallest rate hike in a year

The Federal Reserve increased its benchmark interest rate by a quarter of a percentage point on Wednesday – its smallest increase in a year – taking the federal funds rate to a range of 4.5% to 4.75%. After announcing four consecutive rate hikes of 0.75 percentage points in 2022, and another 0.5 percentage point increase in December, this week marked a return to a slower and more orthodox pace of rate rises.

The shift reflects the fact that data is increasingly suggesting inflation may have peaked, a view supported by the slowing increase in employment costs during the final quarter of 2022. The Bureau of Labor Statistics’ employment cost index is considered the best measure of wages because it corrects for changes in the make-up of the labour market.

Fed chair Jerome Powell’s post-meeting press conference contained a mix of hawkish and dovish statements. He acknowledged there were some encouraging signs that price pressures were easing, but also said it was “very premature to declare victory” and that policymakers would need “substantially more evidence to be confident that inflation is on a sustained downward path”. He also acknowledged it would take time for the full effect of rate rises to feed through to the economy, but indicated that Fed officials are more concerned about doing too little to lower inflation than squeezing the economy too much. Markets chose to focus on the positives, with the S&P 500 and the Nasdaq rising on Wednesday to their highest levels since August and September 2022, respectively.

Markets currently expect rates to peak at just below 5% in the second quarter, followed by 0.5 percentage points of cuts by the end of the year.

BoE suggests rates may have peaked

Here in the UK, the BoE’s monetary policy committee (MPC) voted on Thursday to increase the base interest rate by half a percentage point to 4.0%, a 14-year high. Encouragingly, the MPC said further rate hikes would only be needed if there were new signs that inflation was going to stay too high for too long. This was interpreted to mean that interest rates might peak at the current rate of 4.0%, with no further rate hikes this cycle (markets had been pricing in a peak of 4.5%). This stems from the fact that inflation is expected to ease from 10.5% in December to under 4% by the end of the year and then drop below the BoE’s 2% target in 2024. Nevertheless, the bank said Thursday’s hike was needed because “the risks to inflation are skewed significantly to the upside”.

But ECB vows to “stay the course”

The ECB took a more hawkish tone after announcing a half a percentage point increase in interest rates on Thursday. The increase takes the ECB’s benchmark deposit rate to 2.5%, the highest since the global financial crisis. Whereas the Federal Reserve slowed the pace of tightening and the BoE signalled rates may have peaked, the ECB repeated its intention to “stay the course”, which has become its mantra in recent weeks. The ECB intends to lift rates by another half a percentage point at its next monetary policy meeting in March.

Christine Lagarde, president of the ECB, told the press that while headline inflation had begun to fall in the eurozone, it was still “far too high” and underlying price pressures remained “alive and kicking”. Lagarde’s more hawkish tone can be partly explained by the fact that the ECB began lifting rates later than the Fed and BoE, and it started from a much lower base with interest rates in negative territory until July 2022.

Earnings season gathers pace

Aside from interest rate hikes, a key focus this week was the slew of quarterly earnings reports from US technology giants. We are now halfway through earnings season and the tone is pretty well set, with a host of technology companies reporting this week. After exceeding estimates with revenue of $32.16bn in the fourth quarter, Facebook owner Meta indicated that year-over-year sales in the first quarter of 2023 could rise, thereby ending its streak of year-over-year declines. In contrast, the other major tech giants disappointed. Apple posted its first quarterly revenue decline in seven years after Covid-19 and protests in China disrupted production. Amazon and Alphabet missed expectations, with the latter pointing to lower demand for search advertising. Outside of the tech space, oil and gas giant Shell hit the headlines with record annual profits of £32.2bn – double last year’s total – after energy prices surged following Russia’s invasion of Ukraine.

Nonfarm payrolls smash forecasts

The week climaxed with the release of US nonfarm payrolls data for January, which is the most anticipated piece of macro-economic data each month. Earlier in the week, we had seen indications that demand is cooling with the ISM manufacturing index continuing its decline. In contrast, the Job Openings and Labor Turnover Survey (JOLTS), which has become an excellent gauge of the tightness of the labour market, surprised forecasters with job openings rising and more people quitting their jobs (reflecting their confidence in being able to find a new position). That should concern the Federal Reserve.

Had we acknowledged all the positive labour market data this week, and ignored the much weaker tone from surveys (such as The Conference Board’s survey, which showed consumers believe the jobs market will get looser), it would have been hard to predict the eventual strength of the nonfarm payroll report. An estimated 517,000 new jobs were added during January. Previous months were revised higher too. The average hours worked also rose. Sometimes, the nonfarm payroll report, which is derived from surveying employers, can be countered by the household employment report, which is derived from surveying households. This month, the household survey was even stronger, at nearly 900,000 new jobs. Unemployment declined to 3.4%.

Markets had spent the week relishing the idea of interest rates potentially peaking and inflation drifting lower. These data will make them reappraise that stance.

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