A week in review: payrolls, the Bank of England, and earnings

The pound has been a good indicator of market sentiment this week, as it has been thrashed around in the aftermath of some weak PMI data, the Bank of England meeting, and the aftermath of Friday’s Non-Farm Payroll report for July. As we move through the summer months, there are some themes emerging. The major central banks are making progress when it comes to inflation, the US labour market is finally starting to loosen and this could spread to Europe and the UK. Added to this, the Bank of England’s Inflation Report showed that the MPC believe that inflation will continue to fall sharply this year and the decline will continue throughout 2024. GBP/USD is down nearly 0.4% on the week, however, it attempted a comeback on Friday after weaker Non-Farm Payrolls data reduced the chances of further rate hikes in the US.

The key takeaways from the BOE August Inflation Report:

·      Thursday’s BOE decision was a 3-way split, with 2 members voting for a 50bp rate hike, one voting for no hike and the rest of the members voting for the 25bp hike. This is significant, since our central bank now has three very different opinions about what should happen to monetary policy. Historically, it is rare to have such a large spectrum of opinions, however, we believe that this is mostly down to the pandemic. The post-pandemic economy and the ensuing cost of living crisis has made it difficult to judge and predict the direction of the UK economy, which is further complicated by the impact of Brexit. For example, there is a strong argument to be made that the UK’s inflation rate is being over-stated, particularly for food. The ONS does not adjust for discounts applied by supermarkets to loyalty card holders, so it is only capturing the highest prices that we pay. However, if the BOE is going to make future policy based on economic data, they need to use the CPI, not anecdotal evidence of great deals for Tesco Club card holders. Thus, it makes sense that some members are concerned that inflation will only fall to 5% by the end of this year, yet others are worried that policy is too restrictive since they are reading between the lines when it comes to the official data. Overall, this makes future BOE policy harder to predict going forward, which could increase market volatility.

·      The market has decided that the peak in UK interest rates will be approx. 15 basis points lower than before Thursday’s meeting. The market is expecting UK interest rates to peak at 5.65% in January 2024, and for rates to remain roughly at that level for the first half of next year. This is a dramatic scaling back of UK interest rate expectations compared to June, when the market was looking for rates to peak at nearly 7%. Considering the large amount of variability in the economic data, this moderation in interest rate expectations is a positive development.

·      However, with so many differing views at the MPC, and inflation still well above target, it could be too early to say that the BOE is at a turning point and may lower rates any time soon. Even the BOE noted that the risks to their inflation forecast are skewed to the upside.

·      The BOE expects annual growth of 0.5% in 2023 and 2024, with growth falling to 0.25% by 2025, before bouncing back to 1% in 2026. Thus, no recession is expected, even though Bank Rate has increased. Even so, we would take these GDP predictions with a pinch of salt, as they have been way off the mark in recent quarters and have underestimated the “resilience” of the UK economy, even in the face of various shocks. However, these growth forecasts suggest that growth is likely to be anaemic in the coming quarters, which is nothing to get too excited about, and is another reason why GBP/USD has lost its $1.30 handle in recent weeks and is at one of its lowest levels in a month. The peak in GBP/USD above $1.3130 on 18th July, is now looking like a decent top. However, downside momentum stalled on Friday, after the dollar sold off on the back of the weaker US NFP report.

US jobs round up

·      The dollar experienced its biggest single day slide in 3 weeks on Friday, on the back of weaker than expected NFPs. Jobs growth in the US last month was 187k, which is lower than the expectations of 200k. Job growth is considered to be expanding above 200k, and contracting below 200k, so this is a weak report, especially compared to the massive expansion in jobs growth over the last 18 months.

·      June and May data was also revised lower, which are further signs that labour market tightness is easing  in the US.

·      At the sector level, manufacturing jobs growth declined, but there were strong gains for jobs in healthcare, financial services, and wholesale trade.

·      The unemployment rate dipped to 3.5%, and average hourly earnings growth was also stronger than expected at 4.4% YoY, 0.4% MoM.

·      However, it is worth noting that average hourly earnings are not wage data. For example, because it is an average, lower income employment could decline, without any change in pay. Thus, this data may not be reflective of people having more money to spend. It is worth watching retail sales in the coming months to see if they slow, based on a weakening jobs market. If they do, we will assume expectations for Fed loosening will rise, and this could weigh on the dollar further.

Earnings data helps to prop up stocks

·      Amazon is the latest tech giant to report surprisingly strong Q2 profits, after strong online sales and digital advertising revenues.

·      Earnings were nearly double analyst estimates after the e-commerce business made a comeback. Revenues for Q2 jumped 11% to $134.2bn.

·      This continues the strong performance from Meta and Alphabet, who both reported a decent recovery in digital ad revenues.

·      Semi-conductor demand also helped to fuel a strong earnings report for Intel, and Uber reported its first ever operating profit.

·      The outlier has been Apple, who said revenue declined for a third straight quarter. Amazon also reported bad news in its cloud computing business, which has experienced another quarter of decelerating profits. Yet again, Amazon reported that businesses are trying to save money as rising interest rates bite.

·      Amazon also said that it is starting to see its operational efficiencies – i.e., 27,000 layoffs, boost profits and reduce its cost base. They also said that further staff cuts were likely as they try to consolidate staff around their major hubs.

·      Their forecasts for Q3 revenues and profits were also strong, with Q3 operating income forecast to be between $5.5bn and $8.5bn, better than the $2.5bn reported in Q3 2022.

·      Amazon’s stock price jumped more than 8% on Friday, and it could have further to go as it attempts to break above the key $140 level.

·      Interestingly, the good earnings news from some tech giants wasn’t enough to boost the Nasdaq, which fell on Friday and is lower on the week. This looks like profit-taking, however, the dip below the psychologically important 14,000 level, could see further downside to come in the next few days.

·      Both the Nasdaq and the S&P 500 had their longest losing streaks since May, this week.