The North American equities witnessed a whipsaw action during the month of August, much in line with the flipping narratives observed during most of the year so far. Early in the month, Fitch Ratings, a credit ratings agency, downgraded the ratings of United States’ sovereign credit by one notch from AAA to AA+ citing expected increase in fiscal deficit, growing government debt burden and erosion of governance that has repeatedly brought US on the brink of default around debt ceiling debates. This coincided with US treasury outlining its plans to raise more-than-expected debt during the third quarter of 2023, and Bank of Japan’s announcement of widening the tolerance band for its 10-year bond yields to +/-1.0% from +/-0.5%. These developments corroborated to increase bond yields on both sides of the border. Rising yields imply increasing equity risk premium and thus the equities markets also tumbled.
The sell-off exacerbated after the monthly inflation reports showed the headline inflation in the US and Canada advanced again and the incoming economic data suggested economy is more resilient than expected, reigniting the fears of higher interest rates and for longer. The headline inflation in the US jumped to +3.2% from +3.0% and in Canada jumped to +3.3% from +2.8%. The unemployment rate in the US dropped to +3.5% (reported in August) from +3.6% (reported in July). The caution prevailed for most of the month up until the address of the US Federal Chair, Jerome Powell, at Jackson Hole, Wyoming. Central Bankers, economists, policy makers and academicians meet at Jackson Hole annually to discuss global central bank policies. The speech from the chairman of the world’s most powerful central bank, the US Federal Reserve, remains one of the most important addresses amongst others and given the macro dominated environment during the past few years, the speech assumed even more importance.
At the conference, the US Fed chair emphasized that bringing inflation back to 2% remains the goal of the Federal Reserve, pushing back against any expectations of Fed potentially lifting the target from 2%. The Fed chair acknowledged some softening in labor market as a welcome development but reiterated it remains too tight to consider changing the current restrictive stance of the monetary policy. Bloomberg data suggests the US Job opening data has now surprised on the downside for three consecutive months and the ratio of US Job openings to total unemployed workers has dropped to 1.5 in July 2023 from its peak of 2.0 in March 2022 (See Figure 1). Also, the ‘quits rate’, which measures voluntary job separations as a percentage of total employment has dropped to 2.3% (See Figure 2). High ‘quits rate’ implies more confidence among workers to find another job in the current market conditions and vice versa. The latest jobs data (reported in September) showed the unemployment rate has now jumped to +3.8% from +3.5% and the labor force participation increased from +62.6% to +62.8%, i.e., increase in supply of labor. This above data shows the labor market is becoming more balanced and should reduce the wage-inflation spiral concerns the Fed has been vocal about, in our view.
Figure 1: Total US Job openings to total unemployed workers.
Source: Bloomberg, Bureau of Labor Statistics
Figure 2. United States Quits Rate.
Source: Bloomberg, Bureau of Labor Statistics.
Furthermore, the Fed chair also stated that the bank can afford to move cautiously in the coming months. While the overall message was still hawkish on balance, the investors took comfort from the statement that suggested that Fed might be willing to pause in next meeting and wait a little longer for economic data to evolve before deciding on further course of action. This, coinciding with a few softer macroeconomic data points, supported the view that the lagged effect of tight monetary policy is perhaps beginning to show (supports the case for a pause in policy tightening), leading to a risk-on sentiment during the last week of August. In the US, the estimate of the second quarter annualized GDP growth was revised down to +2.1% from earlier +2.4% and in Canada, the second quarter annualized GDP unexpectedly contracted to -0.2%.
In the wake of recent softening in economic data, Bank of Canada held policy rates steady, however, kept the door open for further hikes if inflation problem remains far from resolved. We believe the US Federal Reserve could deliver a similar message after the FOMC (Federal Open Market Committee) policy meeting in September. The data dependency of central banks implies that choppy economic data would continue to lead to bumpy ride, in the near-term, as investors flip through narratives of a soft landing or hard landing given the mixed economic data. Nevertheless, taking a step back, we think we are closer to the end of monetary policy tightening and thus keep our cautiously optimistic view on the risk assets.