7 November, 2022 - Unemployment is destined to rise.



The US labor market showed a mixed picture in October, but overall the deterioration is now becoming a trend. The non-farm payrolls were announced at +261'000, better than the +200k expected, but at the same time this is the lowest monthly increase since March 2021. More importantly wage growth on annual basis was announced at 4.7%, in line with expectations and at the lowest level since October 2021. Unemployment rose to 3.7% from 3.5%. Overall, the labor market still shows resilience and unemployment is low, but momentum has been lost and the trend now looks to be for higher unemployment and negative prints for the monthly non-farm payrolls in the next 2-3 months. Higher unemployment in the coming months will give the FED a first signal to pause and the bond market to start pricing a recession. This should be beneficial for bond prices, especially the high quality and government bonds, which have too suffered immensely this year.


At the same time, more lay-offs and hire freezes are being announced in the US. Amazon has paused all corporate hiring for at least the next few months, which comes after other reports of a hire freeze in their cloud business. Apple is reported to freeze hiring across corporate roles potentially through Sep-23. UBER's competitor Lyft also announced it will cut 13% of its workforce as management said they see a probable recession sometime in the next year and higher costs. Morgan Stanley became the latest bank set to begin layoffs, primarily in its investment banking business as deal making has slowed down. Twitter is going to get rid 50% of its workforce, according to leaks from internal discussions. Meta Platforms (Facebook) is reportedly going to announce major lay-offs on Wednesday according to a WSJ exclusive article.


Global equities were mixed last week. Shares of big-tech companies in the US (Apple, Amazon, Google, Facebook, Microsoft) were down between 10% and 15% and most of them registered new lows for the year, as the S&P500 closed 3% lower, but remained 6% higher from its recent low at 3500. At the same time, Chinese shares rallied by 6% (Hang Seng up 11%) as speculation is growing that the government is considering relaxing some of its strict Covid19 restrictions. However the officials do not share this view and insist on their existing strategy. At the same time on Friday, during his trip to China the German Chancellor announced that China will approve the Biontech vaccine for foreign residents, which could be considered a (small) step forward. Europe managed to post a mini rally with 2% gains on average and it is worth noting that it has performed better than the US in this recent rebound. European consumer discretionary (LVMH, Adidas etc) posted strong gains.


The FED raised rates by 75bps to 4%, but it is ready to slow down the increases. A new, significant phrase was added to the text: "In determining the pace of future increases the committee will into account the cumulative tightening of monetary policy, the lag with which monetary policy affects economic activity and inflation and economic and financial developments". In J. Powell's own words: "As we move more into restrictive territory, the question of speed becomes less important ... That's why I've said it's appropriate to slow the pace of increases. So that time is coming. And it may come as soon as the next meeting or the one after that". And this is where the dovish part ended... He then proceeded with:

" To be clear, let me say again, the question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive which will be our principle focus". The market pricing of 5% as the terminal rate looks now also to be the FED's own target. At the same time, J. Powell for the first time hinted that a recession might finally be unavoidable, something that we already knew of course given the size and the speed of interest rate increases. Recessions (usually) bring down inflation.


The Bank of England also raised interest rates as expected by 75bps, to 3%, the largest increase since 1989. The main reason behind this large increase was the tight labor market (as is the case in all major economies) which causes concern that inflation might not move down fast enough, despite the first signs in lower demand for goods and services. The announcement also mentioned that more rate hikes are to be expected, but the Governor commented that the terminal rate of 5.25% implied by the market looks to be too high. A final move closer to 4%-4.25% looks more likely.


The Central bank of Australia (RBA) raises interest rates by only 25bps, and is poised to become the first major central bank to stop this rate cycle. According to its Governor, the risk for a recession has increased dramatically, which calls for proceeding with caution from now on with any further interest rate increases.


The Eurozone October inflation was announced at 10.7%, higher than the initial expectations. As already mentioned in our last week's review, there is significant divergence in CPI calculations across the region, as Italy's numbers were "through the roof" with a 4% monthly increase and Spain's inflation was almost unchanged. Overall however, it looks like we have to wait one more month to see whether the annual rate of inflation has peaked. The Core-CPI rose only slightly to 5.0%, vs 4.8% in September. The US October number is due on Thursday.


The USD sold-off at the end of the week, one day after posting big gains. The EURUSD traded close to 1.00 again after hitting a low of 0.9780 the previous day. Barring any major accident in the Ukraine war, one could conclude that we have seen the worst of EUR (best of USD) for now when it hit 0.9500 a few months ago. Gold and Oil rallied on the dollar weakness. The WTI Crude closed the week at 91$, while gold is making an approach to the 1700$ handle.


Bond yields moved higher, as the labor market data were decent and the FED warned that the terminal rate is probably closer to 5%. The US 10-year rose to 4.15%, up about 15bps for the week, while the 2-year rose to more than 4.70% again, up almost 30bps.


Interesting data out of the European Automobile Manufacturers Association showed that electric and hybrid vehicles accounted for 43% of sales of new cars in the European Union in the third quarter. Of that percentage, almost 12% was the fully electric, zero-emission model as sales of such models rose 22% versus the third quarter of 2021, while the rest 31% were hybrids. This statistic has a lot of importance for the results of the automobile companies, as they are now selling higher-priced models, as the overall economic environment has brought down volumes, boosting, thus, their operating margins. The attractiveness of shares like Stellantis, Mercedes-Benz and Volkswagen which come with also rich dividend yields cannot be ignored (5-8%).

 

Chart of the Week :

Jobless claims have started trending higher


This chart shows the continuing jobless claims in the US, or in other words the total number of people who filed for unemployment benefits (ie they lost their jpbs). While the weekly number is still hovering around multi-year lows, the continuing claims number which gives a less volatile picture of the health of the labor market has been trending higher since May of this year. In August and early part of September, there was a move downwards again, but this should probably be attributed to the strength of the hospitality industry (restaurants, hotel, travel). We can see a big spike in October, which is in-line with more and more companies announcing lay-offs and the rest of the macro-economic data deteriorating significantly. As already mentioned, the labor market will be the last economic indicator which could change the FED's mind of how high and for how long interest rate will have to rise.


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• Sources: Chart of the Week : Factset