INVESTORS CONCERNED THE FED MAY BECOME MORE HAWKISH AS US ECONOMY REMAINS RESILIENT

INVESTORS CONCERNED THE FED MAY BECOME MORE HAWKISH AS US ECONOMY REMAINS RESILIENT

This week was a good week for US employees, business owners and, in normal circumstances, it should have been a good week for investors. US business created almost 340,000 new jobs last month, far more than expected. The number of people quitting their jobs increased slightly but this remains well below the recent average, while US manufacturing has remained far more resilient than expected. Business activity in the UK and Europe, as captured by the monthly Purchasing Managers’ Indices, was also better than expected and inflation continues its steady decline.

However, the balancing act between inflation and interest rates has left markets in a cynical mood. The good news is bad news scenario is back with a vengeance as investors look at the strong US economy and expect to see the Federal Reserve taking ever more aggressive action to tame inflation. The result is a sharp fall in bonds and equities, with the US dollar the main beneficiary. Meanwhile, only a week after mentioning the potential for oil to hit $100, a big drop in demand and higher inventories means the price of oil has slumped.

BONDS: SELL-OFF AS INVESTORS FACE UP TO HIGHER FOR LONGER

Government bonds have fallen steeply this week as investors consider the impact of interest rates remaining elevated. Bond yields move in the opposite direction to bond values and US government bonds have continued their recent decline to push bond yields to their highest in 16 years. A big increase in the number of new jobs created this month and better manufacturing output has led to speculation that the period of time that banks will keep rates high is going to get even longer.

UK and European government bonds also fell as central bankers push the message that rates will stay high until inflation is back to target. Bank of England Governor Andrew Bailey expects inflation to dip below 5% this year but said the job is not done yet and European Central Bank President Christine Lagarde said rates will remain restrictive for “as long as necessary”. The negative sentiment was a factor in the general decline in equity markets as the potential for US interest rates remaining high helped the US dollar continue to rise.

UK: BETTER INFLATION NEWS AS FOOD RETAILERS EXPECT PRICES TO FALL

UK retail prices are rising at their slowest in more than a year as retail price inflation fell from 4.7% to 4.4%. A big contributor to the slowdown is the rapid cooling of food prices. Food inflation fell from 11.5% in August to 9.9% in September according to the British Retail Consortium. Despite inflationary pressure from high oil prices and higher borrowing costs, retailers expect inflation to continue to slow this year.

Tesco has upgraded its forecast for annual profits after a very strong first six months of the year. The company has raised its full-year profits guidance to £2.6bn to £2.7bn, up from £2.5bn last year, as sales increased 13%. The company says it is attracting higher-end and budget shoppers by being slower to pass on cost increases to customers. The company says food inflation is expected to keep falling. Greggs has also reported that cost pressures from higher raw materials and energy are beginning to ease as it released an upbeat quarterly update which showed sales up 14%.

EQUITIES: METRO BANK TRIES TO RAISE CASH AS HOUSING MARKET COOLS

Shares in Metro Bank tumbled after it said it needs to raise £600m. The bank recently applied to use its own data to assess the default risk of its mortgage lending, instead of using industry standard data. The UK’s largest banks typically use their own data as it can increase profitability by reducing the capital reserves required. Last month Metro Bank was refused permission to use this method and its shares have fallen heavily since then. The rest of the banking sector has been unaffected. Although bank shares have fallen this week, this was in line with the broad UK market.

Meanwhile, the UK’s housing market continues to slow. Average house prices are falling in all regions of the UK for the first time since 2009 as data from the Bank of England shows mortgage applications are at their lowest in six months. Economic activity in the construction sector has fallen steeply, mainly due to a slowdown in house building.