JP’s Journal: Walking a tightrope

The US economy continues to confound the sceptics. Last week’s employment data showed upside surprises across the board.

Non-farm payrolls were up 254,000, significantly more than the consensus of 150,000 and there were positive back revisions as well. Reflecting this, the unemployment rate fell to 4.1% whilst average hourly earnings came in a touch stronger than expected. For those looking for the Federal Reserve to accommodate another 50bps cut, these numbers are not supportive. The US economy is not sliding into recession and most sectors saw payroll gains.

For those looking for the Federal Reserve to accommodate another 50bps cut, these numbers are not supportive.

Bond markets reacted to the data by selling off, with the US treasury 10-year rate closing in on 4%, a near 20bps rise on the week and 40bps above the September low of 3.6%. The UK followed this move with the 10-year gilt yield moving above 4.1%, for a 15bps hike over the week. UK real yields also rose, but by less, with breakeven inflation nudging higher. Credit markets outperformed – spreads were broadly stable in investment grade markets but fell in high yield. Overall, the moves indicated that investors are happy with the economic direction of the US.

The escalation in Middle East tensions has, so far, had little impact on markets. The US dollar has been stronger, and oil prices have risen. But in both cases the reaction has been muted. Looking at the oil price, the range in the last two years has been $70-80 a barrel. The recent move up has only taken the price into the mid-point. Is this complacency or recognition that Saudi Arabia and the UAE can adjust supply if there was disruption to Iranian supply? Overall, markets seem to be rational.

The UK Budget is getting harder to call as the certainty of political manifestos gives way to ambiguity caused by economic  realities. There can be little doubt that there has been an economic impact from this uncertainty as consumers and businesses fear the worse. Getting the balance right between fiscal prudence, encouraging growth and not frightening bond markets is a delicate act. It now seems that the tax rises may not be as wide ranging as first suggested but if this means a large jump in gilt issuance there is a risk that borrowing costs, for both the government and homeowners with mortgages, will rise. Let’s hope that the Chancellor gets this right.    

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