Stephen Miller
There seems to be ongoing indications of “last mile” complications in getting inflation back to target in a number of “Anglo” economies.
At the same time, labour markets are showing signs of cooling.
That presents central banks with a potentially difficult “high wire” balancing act: trying to get inflation back to target, and anchoring inflation expectations, but without causing an excessive dislocation in the labour market.
Central banks may still cut policy rates in the face of “sticky” inflation. More problematic will be the response in bond yields which, reflecting stubborn inflation, may be “sticky” despite central banks cutting their policy rates.
As an illustration, the European Central Bank has cut its policy rate from 4 per cent in June 2024 to 2 per cent currently but the German 10-year government bond has barely moved in that time.
Were that to be repeated elsewhere, then persistent high bond yields might yet prove to be a headwind of sorts for equity markets.
Having said that, there is more than bond yields driving equity markets recently.
Bank of Canada
On Tuesday night Canada released September consumer price inflation (CPI) numbers that were above expectations. Headline CPI rose to 2.4 per cent against a consensus expectation of 2.2 per cent. More worryingly, the median and trimmed-mean measures came in at 3.1 per cent and 3.2 per cent respectively against an expected 3.0 per cent.
That compares with a target for inflation of 2 per cent.
Meanwhile Canada’s jobless rate stands at a troubling 7.1 per cent – much higher than Australia, the US and UK.
Not surprisingly, Bank of Canada Governor Tiff Macklem has been exercised by Canada’s labour market labelling it “soft”.
Further, Bank of Canada Deputy Governor Rhys Mendes recently warned of putting too much emphasis on the Bank’s two preferred core inflation measures – the median and trimmed-mean gauges.
Mendes said the central bank is weighing a broader suite of gauges that suggest underlying price pressures are closer to its 2 per cent target.
Hmm…maybe! But I can’t help thinking that sounds a little disingenuous.
Of course, Canada has been particularly affected by the US Administration’s trade agenda.
And markets didn’t seem overly fazed by the higher inflation numbers reducing the probability of a further cut at the next meeting on 29 October only marginally from around 80 per cent to 70 per cent.
Bank of England
Unusually among the “Anglo” economies UK inflation surprised on the downside.
Core inflation was flat in September to be up 3.5 per cent over the year from 3.6 per cent in August and compares with a consensus expectation of 3.7 per cent. Headline inflation came in at 3.8 per cent compared with an expected (by both the market and the Bank of England (BoE)) 4.0 per cent.
However, that is well north of the target 2 per cent.
And it is the case that services inflation remains elevated at 4.7 per cent while labour cost growth is close 5 per cent.
However, the BoE may take some heart in the undershooting of the expected cyclical peak of 4 per cent that was expected to arrive in September.
The September inflation report follows on from a higher than expected unemployment rate of 4.8 per cent in August that was released last week.
Markets remain sceptical of a policy rate cut at the meeting scheduled for 6 November. In the wake of the September inflation data markets were pricing the probability of a reduction at that meeting at around 35 per cent (up from 10 per cent prior to the release).
United States Federal Reserve
This Friday sees the release of the September CPI for the US.
Markets are looking at an increase of around 0.3 per cent in core CPI which would leave the annual rate at 3.1 per cent from a trough of 2.8 per cent in May. A little more worrying is that the “inflation pulse” – the 3-month annualised rate of core CPI increase – would then be around 3.9 per cent, up from a trough of 1.7 per cent in May.
The annual median and trimmed-mean measures as calculated by The Federal Reserve Bank of Cleveland were at 3.6 per cent and 3.3 per cent respectively in August.
That compares with a Fed inflation target of 2 per cent, admittedly focused on the core private consumption expenditures price index (core PCE) which is currently running around 0.2 to 0.3 per cent below the core CPI. But that is still well north of the Fed’s 2 per cent target.
On the surface, it is also difficult to reconcile those sorts of inflation rate measures with 10-year bond yields sustainably below 4 per cent, particularly given the magnitude of the US budget deficit funding task.
Meanwhile the US labour market has shown signs of cooling – not as yet alarmingly so, but cooling nevertheless.
Certainly, markets seem to think that signs of a cooling labour market will be foremost in the Fed’s mind when it meets on 29 October with them pricing a near certainty of a 25 basis points reduction at that time.
With the median September “dot plot” indicating cuts in October and December those market expectations seem fair enough.
Nevertheless, it is still a “high wire act” that the Fed needs to perform to balance both sides of its mandate.
And “sticky” bond yields – while not currently “front-of-mind” for equity markets – may yet prove a headwind for equity performance and the economy.
Reserve Bank of Australia
There seems to be a hint of “last mile” complications in getting inflation back to the middle of the RBA target 2 to 3 per cent range. The August monthly CPI indicator points to meaningful upside risks to the RBA quarterly trimmed-mean inflation projection. The RBA projection for the September quarter is close to 2.6 per cent. In the wake of the August monthly report, likely outcomes for the September quarter CPI are likely to be closer to 2.8 to 2.9 per cent.
Labour cost growth remains elevated, exemplified by unit labour cost growth of around 5 per cent and are consistent with upside risk to RBA price projections.
Meanwhile, as is the case elsewhere the labour market has shown signs of cooling. As in the US, there is as yet little evidence of an alarming decline, although the September labour force report revealed a surprising increase in the unemployment rate to 4.5 per cent from 4.3 per cent and compares with the most recent RBA projection of 4.3 per cent at year-end.
The non-market sector has been the overwhelming driver of jobs growth. However, there has been some suggestion of doubt around the durability of that contribution.
Westpac estimates that the non-market sector (healthcare, education and public administration) has accounted for 95 per cent of the growth in hours worked in the economy over the past couple of years and, further, if non-market job creation over this period had run at its pre-pandemic pace, the unemployment rate could be up to 1 percentage point higher.
With growth in public spending set to slow there will likely be an attendant slowdown in non-market sector employment. With private spending (at least until recently) showing only tepid rates of growth it was thought doubtful that market sector employment is in a position to pick up any slack.
The September labour force report will only reinforce those concerns, but it is only that one report and given the “last mile” complications the RBA might like to see one more labour force report before making a final judgement on the strength, or otherwise, of the labour market.
Of course, next week’s September quarter CPI report is critical. A quarterly result above 2.7 per cent will make it difficult for the RBA to cut the policy rate at its 3-4 November meeting. An outcome of 2.7 per cent probably means a 50/50 chance of a cut while anything below 2.7 per cent probably “green-lights” a cut.
Even if the September quarter trimmed-mean CPI comes in above 2.7 per cent, the RBA may well still cut at its December meeting if the October labour force release (on 13 November) appears to confirm the weakness evident in September.
By Stephen Miller, investment strategist
