Monday Espresso Podcast 5th December 2022

[00:00:00] Sheldon MacDonald: It is the 5th of December today, we had a strong week last week capping off a strong month for equities and bonds. Pretty much across the board, markets doing pretty well last week's strength based on lower inflation readings and also some comments from the Fed. So let's tackle each of those. In turn, Nathan, the lower inflation figures.

[00:00:20] Nathan Sweeney: Yeah, so we had inflation figures coming out of Europe last week, so we all know that inflation in the US has been falling, but interestingly, if we look at the numbers that came out of Europe, this is the first time that they've been lower in a long time.

[00:00:34] Nathan Sweeney: So inflation was expected to come out at 10.4%, and it was actually lower than that, it came out at 10%.

[00:00:42] Nathan Sweeney: So the first sign that inflation may have peaked in Europe and is now beginning to trend down. Let's hope so.

[00:00:50] Sheldon MacDonald: We've been saying for some time the underlying driver's inflation coming down across the board, some of the things that pushed inflation up so much, food prices, shipping costs, all of those have been falling for some time.

[00:01:01] Sheldon MacDonald: So gratifying now to see it finally reflected in the numbers in Europe. Let's turn to the Fed comments. So Chairman Powell indicating really that 50 points pretty much is a certainty for the next interest rate meeting.

[00:01:14] Nathan Sweeney: Yeah, so what tends to happen is you have the central bank and you'll have all of the members that sit on the committee.

[00:01:21] Nathan Sweeney: Now, those members will often attend various different press conferences, presentations, et cetera, and at those meetings they will use that as a basis to get their messaging out. So what we've seen recently is that a number of central bankers, which sit on the committee, so the Feds central bank committee, they've all been saying the same thing, that they expect the level of interest rate increases to be less.

[00:01:45] Nathan Sweeney: So if we look back over the last four meetings, we've had increases of 0.75%, and the expectation is that is going to be lower going forward. So half a percent, and what that tells us is that central banks believe they have inflation under control, and that's why they're lowering the pace of those increases in interest rates.

[00:02:07] Nathan Sweeney: So that's quite an important point.

[00:02:09] Sheldon MacDonald: Let's just park that point for a second, finishing off on the week, the strength in markets, in equity markets in particular, did see the VIX index fall below 20. Now the VIX index sometimes called the fear index, it's an index of option pricing, measures the volatility in markets, expected future volatility, when that falls, that's an indication that markets are quite confident.

[00:02:33] Sheldon MacDonald: But a fall below 20, indicates perhaps that there's a little bit of complacency around in the markets, that markets are almost willing to sound the all clear that things are going to be fine.

[00:02:42] Sheldon MacDonald: We think that's a little bit premature. Analysts have been dropping their forecasts for earnings growth for next year, but analysts still on average expecting 5% earnings growth in 2023 from current levels.

[00:02:56] Sheldon MacDonald: We think that's a little bit of a stretch given the, the risks in the market, given the level of inflation in the market, and the fact that we haven't yet seen the full impact, the lagged effect of all the interest rate hikes that have been put through already.

[00:03:10] Sheldon MacDonald: So perhaps as we say, a little bit of complacency and we are maintaining for now a relatively cautious stance.

[00:03:16] Sheldon MacDonald: Now, coming back to the inflation picture, the jobs market is still pretty hot. We saw some jobs figures last week, Nathan.

[00:03:23] Nathan Sweeney: Yeah, so interestingly, if we look at unemployment in the US, it's 3.7%. So it is a little bit higher than the record low that it sat at earlier in the year.

[00:03:33] Nathan Sweeney: However, what you're seeing is that the number of jobs which are being created each month is still quite high and you know, that just reflects that a lot of employers are still trying to hire people in this post pandemic world and the issue with that is that the more people you have working, the more people you have spending, which likely feeds through into inflation because you're also seeing wages increasing as well.

[00:04:00] Nathan Sweeney: And the problem is, as we know that central banks are trying to squash inflation by increasing interest rates.

[00:04:06] Nathan Sweeney: So there's a bit of a balancing act there between central banks and employers hiring and what the central banks would like to see is that unemployment goes up as in rises, and therefore you have less people spending, which reduces growth, which in turn reduces inflation.

[00:04:23] Sheldon MacDonald: Yes. Now, as mentioned Fed Chairman Powell, he's on record as saying wage inflation is pretty much the main thing that they need to get a handle on and so the jobs figure that we saw last week really is a bit of a reminder that even if the pace of rate hikes might ease from here, the terminal rate, the peak point of rates might be higher than people are currently expecting.

[00:04:46] Sheldon MacDonald: Turning our attention elsewhere in China, some good news there that perhaps there's an easing of Covid restrictions happening. Any news on that, Nathan?

[00:04:57] Nathan Sweeney: Yeah, so I think there was a lot of concern last week that you might see restrictions coming in that were more restrictive, and there's obviously a lot of pushback, so there's a lot of social unrest and people protesting about the fact that you might have more restrictive lockdowns within China, and the government has turned around and said that they're looking to essentially not have strict Covid policies in place, so relaxing those measures, and that's good for a number of reasons.

[00:05:25] Nathan Sweeney: Firstly, because obviously opens up the economy, increases growth in China, and therefore that should be good for the global economy.

[00:05:33] Sheldon MacDonald: Certainly good for the demand side of the global economy, but on the other hand, that higher demand essentially could lead to a higher oil price amongst other things, and that then feeds back through to higher inflation.

[00:05:45] Sheldon MacDonald: Now, I mention oil because there is an OPEC Plus meeting this weekend, which we'll be watching with keen eyes to see what comes out of that.

[00:05:53] Sheldon MacDonald: Anyway, that's all we've got time for. Thank you for listening, and we look forward to speaking to you again next week.