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July 8th, 2024 - Are consumers (and economies) reaching their limits ?

The central bankers believe that they can engineer a "soft landing" of the economies while pushing inflation to below 2%. Hence they have kept saying lately that they are willing to keep interest rates high for a long period of time , pushing back on the markets' view that rate cuts are coming. Our view has been that inflation will be on a sustainable downward trajectory when the economies start "cracking", and the demand for goods and services grinds to a halt. Then again, central bankers claim that they do not wish to throw the economies into a recession, but they could be in for a surprise, as consumers can collectively change their minds very quickly .

High interest rates have primarily hurt the low income parts of the populations and demand for consumer goods has really started to drop as can be seen in the falling prices of many categories within the inflation reports. Consumer services remain the biggest problem for inflation as rents, insurance and travel & leisure costs continue to rise at a higher-than-wanted rate. But, evidence is surfacing that the consumer has "had enough" of ever increasing prices in the services industries too. This could have significant implications on the economies, on inflation, and of course on the investment landscape (positive for longer term bonds, positive for defensives and negative for cyclical stocks in the equity markets).

To this end we highlight the big miss of the ISM Services index in the US last week. The equivalent of the PMI index but calculated by the Institute of Supply Management (ISM) collapsed in June to 48.8, from 53.8 and compared to expectations for a mild fall to 52.5. This is the lowest level since the pandemic years and although the series have been volatile this year, it could finally highlight a softening in services demand. Just to mention one example, according to respondents to the ISM survey in accommodation & food services, "Sales and traffic remain soft compared to last year. High gas prices in California and constant news about inflation and restaurant menu prices are the culprits".

The US labor market report also confirmed the slowdown in services and the economy overall. The June non-farm payrolls was announced at 206k vs expectations for 160k, but the previous two months were revised down by 110k. Looking into the details, professional and business services lost 17k jobs in June, leisure & hospitality jobs rose by only 7.3k, the lowest pace in many months, while the retail industry shed 8.5k jobs, underlining the weakness in the consumer-related sectors. In other reports of the week, the continuing jobless claims rose to 1.86mn which is the highest level since the pandemic and the unemployment rate rose to 4.1%. These numbers in absolute terms do not necessarily "cry out" recession, but what is important is the direction of travel, which shows that the labor market continued to deteriorate.

Inflation data and central banks are entering again the stage. In the Eurozone, June inflation fell by 0.1pp to 2.5% y/y, as expected. At the component level, the decline was driven by lower energy (-0.1% to 0.2% y/y) and food inflation (-0.1% to 2.5% y/y). But core inflation disappointed, staying unchanged at 2.9% y/y, against expectations of a small decline to 2.8% y/y. Within core, both goods and services inflation were unchanged at 0.6% y/y and 4.1% y/y, respectively. In Switzerland, June CPI was unchanged on a monthly basis, bringing the yearly change down again to 1.3%, from 1.4% the previous month. As a reminder, the SNB is the only major central bank that has already cut interest rates two times this year. On Thursday, we will hear from the US, where expectations are for inflation to drop to 3.1%, down from 3.3%. Core inflation in the US is expected to have stayed at 3.5%, still at an uncomfortable level for the FED.

The ECB is meeting next week, but many members have already been cautious in their policy guidance since the last meeting in June. They have all highlighted the fact that the June rate cut was not the beginning of a series of rate cuts every month or even every quarter, as the market initially thought and priced. The central bank wants to maintain the flexibility to act as deemed appropriately at each meeting until the end of the year and next week we will find more on their thinking.

The ECB forum in Portugal last week, confirmed this message. President Lagarde noted that the strength of the Eurozone’s labor market meant the ECB had time to gather more information to be certain inflation was on track. The Chief Economist Lane said it will take a while for the ECB to assess incoming inflation data, and certainly there remained questions regarding service sector inflation. Vice President de Guindos said that the ECB needed to be prudent and mindful that base effects had been a large part of the inflation slowdown of late. Mr. Powell of the FED, who attended the forum, also mentioned the central bank's willingness to wait for longer before they cut rates , as more confirmation is needed that inflation is on a sustainable downward trajectory.

The French 2nd round elections became a referendum on Le Pen, as results showed. The strategy of the left and the centrists to remove their candidates who came third in the first round, pushed many voters to just vote the remaining candidate to oppose the one of Le Pen's party. The final result is what is called a "hung parliament", where a three-party coalition government is the only viable solution. New elections cannot be held until July of 2025 and France is entering a period of uncertainty, but having avoided perhaps much worse outcomes. The French mutlinationals which have been beaten down in the last few weeks could see a rebound.

Equities rebounded further and the S&P500 closed at a record high with a 2% gain for the week. Nasdaq rallied by 3.5%, but we should highlight the drop in the small caps index Russell 2000 by 1%, in an overal party atmosphere. Small caps are more sensitive to economic cycles and their large underperformance this year points to a fear about the ongoing slowdown. Europe managed to rebound by 2% on average, as French stocks were bought again. No-one (but us) is looking for protection and Swiss stocks ended the week flat, at the index level.

The 2nd quarter earnings season begins the week in the US, and expectations have risen primarily in the Tech sector. Traditionally the major US banks are the first to report and on Friday we will hear from JP Morgan, Citigroup and Wells Fargo. The big Tech names will start reporting in three weeks time, and as a reminder last time we had some major "accidents" by disappointing results (Meta Platforms, Alphabet). Of course both stocks have recovered since then, on no major news but rather the desire of traders and investors to own them. It would be interesting to see if the companies will announce better results this time, which would be compliant with the rally in their share prices in the previous three months.

Bonds continued to perform well, as the macroeconomic data in the US disappointed again. The US 10-year yield finished below 4.30% and the German equivalent yield fell to 2.53% in sympathy. We will not get tired mentioning that any significant rise in yields should be bought by investors as the highest quality long-duration bonds provide the best hedge against any turmoil in the equity part of their portfolios.

Chart of the Week : The US job market is weaker than reported, most of the time since early 2023.

We have been critical about the reliability of the monthly labor market data (non-farm payrolls) since the pandemic. To begin with, the fact that they are based on telephone surveys of households and then the answers are thrown in computers where an algorithm takes into consideration seasonality and other factors to spit out a number does not provide much confidence, but it has always been like that. But the pandemic had messed up things, as large parts of the population lost their jobs for a few weeks or months , then switched to freelance work, meaning that when they replied to the surveyor they had 3 or 4 jobs at the same time, and this total number was added to the model instead of one person working in the household. The above chart shows the evolution of the non-farm payrolls since the pandemic and how it has been overstated or understated based on the revisions that happen every month. In the green areas the "true" jobs are the upper part of the line and the bottom line was the original estimation (so they were grossly understated). In the last one and a half years we see primarily large red areas. In these periods the revised jobs numbers are the bottom line and the top is the initially published. It is very apparent how the monthly figure has been overestimating the state of the labor market, for almost two years now. We keenly wait to see what the next six months until the year end bring in terms of jobs growth, where the trend is clearly down.


• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Macrobond


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