Synchronised Rate-Hikers Start To Disperse

A generally bullish, risk-on week aided by talk of Europe/UK set to lower interest rates – while the US is still somewhat undecided. The synchronised rate-hikers are starting to disperse:

1. Switzerland cut -0.25% to 1.50% in March. It was a surprise move. Inflation has come down and is within the CB range. The Swiss Franc has fallen this year.
2. Sweden has lowered rates from 4% to 3.75% and is poised to do so again if inflation stays under control. The currency is the issue – it has weakened and this stokes inflation (higher import costs).
3. The EZ has captured headlines and is expected to make 3 cuts this year as inflation there, which has fallen fast, is close to its 2% target.
4. The UK held rates this week at 5.25% but there was an optimistic overture from the Governor who hinted strongly of 2 rate cuts.
5. The US has been a real stickler over rates. However, there are possible cracks beginning to emerge as a recent result of jobs data. Last month’s Nonfarm payrolls were softer than expected and this week’s jobless claims saw a big rise vs previous weeks. Is this a sign of tempering in what has been a robust job market.
6. In NZ and Australia there are no signs of change any time yet – October-November is the current reckoning. In Australia, a 20% of a rate cut is attributed to August.
7. Norway stays on hold and for possibly longer than initially thought – this in its hawkish announcement early this month.
8. Japan is something of a mystery. Economic data (e.g. like Friday’s consumer spending) is still weak. Meanwhile, the services sector is buoyant though manufacturing is still downbeat. The weak Yen is great for corporate exports but terrible for higher import prices and raw materials prices.

Given the above picture and summary, right now Europe/UK offers the best return trade off. These markets are cheap and stand to benefit from FX appreciation as global fund flows result in rebalancing. Inflation is slowing much more quickly in Europe than the US. A US consumer sentiment survey (by the Univ. of Michigan) posted an initial reading of 67.4 (down from April’s 77.2). That’s a -12.7% m/m. The driver of this decline is an expectation one year inflation will rise to 3.5% (+0.3% m/m). The 5y outlook also rose to 3.1% (+0.1% m/m).

Energy, food, wages and accommodation are four, key factors determining the future path of inflation and rates. Energy prices have slipped back lately as stockpiles pick up. Food is a difficult one - the energy component of food harvesting, processing and distribution is fairly steady but the weather aspect is unpredictable. That leaves wages and accommodation. The demand for skilled workers hasn’t changed but immigration is playing a key part in setting employment trends – and this could be the latest factor behind jobs data. The chart below compares population growth rates over 2021, 2022 and 2023.

In 2023, out of every 1,000 residents, 32 people were imported vs 10 in the US! Over the past two years, 2.4mn people arrived in Canada – more than the population of the state of New Mexico! So, the arrival of migrants is helping to fill capacity and temper wage growth. That has definitely been reflecting in latest jobs data.

Which comes onto accommodation. A country like Canada can barely provide for enough housing for many of its cities. Housing starts in Ottawa are down -7% in 2023. It’s an all-too familiar story – and helps drive up accommodation costs. In the US, housing costs are rising at around +0.50% m/m and form a core, sticky part of inflation there. There is an argument that the inability to keep up with housing demand (whether by design or accidentally) places a natural cap on immigration. Continuing with the Canada theme, look at how rents have risen:

The Canadian home price index has soared too rising to an index of 354.4 from 1980 to end of 2023. In the US, it has risen 183.4 over the same period (even that’s high).

Many people have struggled to understand why some components of inflation are “sticky”. Hopefully the above gives you a sense. Accommodation is not really going to be altered by energy or food. It’s structural in nature and works around people and Landlords. The key variable is construction (private and public) and constructors have seen costs go through the roof thus disincentivising widespread new construction. Real wealth starts with property – that’s why Baby-Boomers are in a strong place because they sit on a lot of properties built post war.

MARKET SUMMARY