The US economy added another 531,000 jobs to payrolls in October – that was higher than expected. Moreover, the figure for September was revised up from 194,000 to 312,000. That was still below the 500,000 that had been expected for that month – but, as you can see, it was a great deal less disappointing than markets thought at the time.
(This is another useful reminder of just how flaky this data is. It doesn’t prevent markets from reacting to it, but I always find it useful to imagine what might have happened if the revised data had been announced on the day – how would that have changed the “narrative” for markets?)
Anyway – if this had happened last week, a strong jobs report might have sent investors running for the hills; stronger employment would have meant tighter monetary policy.
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But something happened last week to change the tone in markets. And I think that’s worth delving into a bit.
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The Bank of England’s brief turn in the spotlight
It’s all about what markets had been expecting – and how that changed very quickly. As usual, it’s mostly about central banks.
In terms of the importance of central banks to investors, the US Federal Reserve is generally the big one. It sets the tone – particularly in emergencies – and the other central banks follow it.
However, we’re at an inflection point at the moment. And it’s one where the smaller central banks have been taking the lead.
We’re already seeing central banks across various emerging markets and smaller developed markets raising interest rates. For example, Norway raised rates in September, while Poland has raised rates quite aggressively.
So last week, even although there was an important Fed meeting, lots of eyes were also upon the Bank of England meeting.
The Bank is in no way as important as the Fed, and most of the time its individual rate meetings simply don’t matter that much to global markets. Hordes of analysts don’t sit on Twitter immediately parsing changes to commas and semicolons for hints as to what the Bank might do next.
But it’s still a big central bank and sterling is still a significant currency. So the idea – which had been very much leaned into by Bank governor Andrew Bailey – that the UK might be next to raise interest rates had global investors preparing for a wave of hawkishness.
Taken altogether, markets seemed to feel as though they’d been wrong to assume that central banks were relaxed about inflation, and that the risk was being caught on the hop as a wave of rate hikes swept the globe.
Central banks are behind the curve, which is where they want to be
Yet as it turned out, betting on central banks being more dovish than they’ve led markets to believe is still the winning trade.
First came Wednesday, when we had the Federal Reserve sounding a good bit more relaxed than had been expected about inflation.
Yes, the Fed started the “taper” – the process of winding down quantitative easing (QE). But Fed chair Jerome Powell was at pains to emphasise that inflation is still transitory, and that the end of QE doesn’t mean the imminent start of rate hikes.
That left markets feeling pleased but slightly disorientated. QE was ending – but not as fast as they’d expected, and with no sense that the Fed is especially worried about inflation.
Then came Thursday, and the Bank of England’s turn in the spotlight. We’ve already pointed out that the Bank really shocked markets with its resounding decision not to raise interest rates. That sent sterling significantly lower.
However, what was probably more interesting is the way the decision reverberated around other global markets. Coming hot on the heels of the Fed’s relaxed attitude, it seemed to convince investors that we’re back to a policy of “watchful waiting”.
In short, markets went into last week thinking that central banks were going to act on inflation. Increasingly aggressive noises from the Bank of England in particular, had convinced investors that they’d better get ready for rates to rise a lot faster than they’d expected.
But by the end of last week, they’d been disabused of that notion. It turned out that central banks had been talking a big game, but had decided to err on the side of caution on the day.
Overall, markets are comfortable with this. They don’t want central banks to push up interest rates. That would be bad news for asset prices.
However, it does also increase the risk that inflation keeps going higher and that we get to the point where even if it can be described as “transitory” it starts to be much more disruptive. As Michael Pearce of Capital Economics put it, there is “an increasing risk that the Fed is falling behind the curve”.
For example, the latest jobs report shows that wages in the US are rising at a rate of 4.9% a year. To be clear, higher wages are not a bad thing. But they are the most obvious vector for driving ongoing inflationary pressures – the one thing that might not be easy to dismiss as “transitory”.
We’re not there yet, and if supply chain issues start to relax, we might not get there for a while. (It’s not been as widely reported on as the spikes were, but the cost of shipping as measured by the Baltic Dry Index has fallen precipitously in the last few weeks).
But it leaves me more convinced than ever that the point is to hold “real” (after-inflation) interest rates down below inflation for as long as possible. Which is yet another reason to prepare your portfolio for a more inflationary backdrop than most of us have seen in our investing careers.
This is a topic we’ll be discussing in some detail at the MoneyWeek virtual Wealth Summit. If you haven’t already bought your ticket, find out more here.
