Over the past two weeks the key events have been the central bank monetary policy decisions from the Bank of England (BoE), US Federal Reserve (Fed) and the European Central Bank. We have also progressed through the latest earnings season in the US, with more than half of S&P 500 companies having now reported their results for Q4 2022.
However, the narrative remains unchanged. A US recession continues to be likely, with further interest rate rises implied by the Fed implying an associated negative impact on economic growth. As we’ve stated before, the extent of rate rises remains unclear; indeed the latest US jobs print on Friday 3rd February surprised strongly, further underlining the strength of the US jobs market, suggesting a ‘higher for longer’ interest rate policy remains a possibility.
Analysts’ prior expectations of US companies’ earnings in Q4 were depressed, but many companies have surprised by reporting better than expected results. As a consequence equity markets have maintained upward momentum so far this year, against a background of falling core inflation and an increased risk appetite. Despite that, Q1 2023 forecasts remain subdued.
Keeping an eye on the data
We are currently in the second half of the US reporting season and as of 3 February, approximately 70% of companies have reported positive earnings surprises. However, the market is focused on companies’ forecasting guidance for this year; 37 companies have issued negative guidance for the coming quarter, compared to 6 companies which have issued positive guidance (data from FactSet).
Last week saw the latest central bank meetings with the expected interest rate rises from the Federal Reserve (0.25%), Bank of England (0.50%) and European Central Bank (0.50%) all confirmed. Given the moves were as expected, focus turned to the press releases and interviews with Bank leaders that follow the interest rate decisions.
Chair of the BoE Andrew Bailey indicated that whilst we are close to the peak level of interest rates, their arrival may not be imminent. More positively however, the revised estimates for GDP in the UK indicate a much shallower recession than previously forecast, ie -0.7% GDP growth versus the earlier estimate of -2.0%.
The Fed statement following the 0.25% rise in US interest rates also persuaded the market that rates were close to their peak. However, strong US jobs data late last week fuelled expectations that the terminal interest rate could be higher than is currently priced in by the market.
How fast will inflation keep falling?
Inflation, especially in the US has fallen from its high at a faster rate than the market had anticipated. This has fuelled the increased risk appetite from investors that has driven stock market returns over the last few months. The question remains however, whether the pace of disinflation will be maintained, and when it will reach the central banks’ target levels?
The below chart shows that whilst goods inflation in the US has begun to come down, it is still significantly above normal levels and that services inflation continues to rise:
Source BCA Research 3rd February 2023
It is worth highlighting that food price inflation has continued to rise too, and is yet to show signs of rolling over.
Jerome Powell, chair of the Fed, did remark that the market currently expects inflation to fall at a faster rate than the Fed does, hence the difference between the Fed’s future interest rate expectations and the market’s. Investors have begun to price in expected rate cuts for later this year as a result.
With monetary policy already at restrictive levels, inflation is expected to fall but remain above the 2% target at the end of the year. This being the case, restrictive monetary conditions still appear likely to lead to recession albeit milder than perhaps might have been the case
In Europe and the UK, inflation remains high but the impact of the increase in energy prices last year should come out of the data in the coming months. Natural gas prices have come down significantly from their peak as shown in the chart below.
Source BCA Research 3rd February 2023
Inflation data for January could shed further light on how this is playing out and this is due next week from the majority of major economies.
As we have said, there is a lack of consensus among forecasters, with some quite different outcomes being considered equally as ‘likely’. Investors would be wise to retain their current positioning until the outlook becomes clearer.
Until next time stay well.