MARKETS COOL AS CENTRAL BANKS REPEAT WARNINGS THAT RATES MAY GO HIGHER THAN EXPECTED

MARKETS COOL AS CENTRAL BANKS REPEAT WARNINGS THAT RATES MAY GO HIGHER THAN EXPECTED

This week a steady drip of data suggests economies are holding up ok, despite the major increase in interest rates specifically designed to make things worse to fight inflation. A surprising 500,000 jobs were added in the US, while the UK narrowly avoided recession for another quarter. Markets have taken this news to heart and adjusted expectations accordingly. Taking this data at face value is probably unwise, the UK avoided recession by the narrowest of margins and the GDP figure is notoriously unreliable as it is often heavily revised as more information becomes available. US jobs data is especially unreliable in January as the annual review of statistical assumptions has an impact on the figure year to year.

While the market is easily fooled by headlines so too, unfortunately, are central banks. The true state of the economy won’t be clear for months so policy makers have to make do with the data they have, while the impact of today’s decisions won’t be apparent for another year. Driving in the fog, not sure what direction you’re going, usually leads to an accident and is a fair analogy for why economic soft landings are so hard to achieve.

US: STRONG JOBS MARKET FORCES A REVIEW OF RATE EXPECTATIONS

The US jobs market appeared far stronger than anticipated as more than 500,000 new jobs were created in January. This was far higher than the 190,000 forecast and caused Federal Reserve chair Jerome Powell to repeat his warning that interest rates are likely to rise higher than markets expect and then remain high for longer. Powell was joined by several other members of the Fed in making the case for higher interest rates if inflation remains stubbornly high. In the UK, Catherine Mann, a member of the Bank of England rate setting committee, said the UK is more likely to raise rates than cut them to ensure inflation is brought under control.

Markets initially rallied on the positive employment data, but the warnings from the US central bank caused US government bonds and US equities to decline. UK government bonds also fell while the dollar climbed against the pound and the euro as foreign exchange markets factored in the potential for more rate hikes in the US.

UK: OUTLOOK IMPROVES BUT QUESTIONS ABOUT RESILIENCE REMAIN

The UK avoided recession in 2022 as GDP remained unchanged in the final quarter of the year. The International Monetary Fund has singled out the UK as the only developed economy expected to fall into recession in 2023, however, the National Institute for Economic and Social Research estimates the UK will avoid recession with modest annual growth of 0.2%. It expects unemployment to rise slowly and says older workers who left the workforce during the pandemic are likely to return to the workforce to deal with higher living costs. However, the NIESR says high inflation means it will feel like a recession for many people, with up to 7 million people unable to meet all their bills and disposable incomes falling by up to 13% for middle earning households.

Meanwhile the FTSE 100 hit a new all-time high as it passed the previous high water mark from 2018. The index of the UK’s largest companies has benefited from strong profits from the energy sector and the weaker pound has boosted the value of overseas earnings.

EQUITIES: BIG TECH SEES AI AS THE KEY TO ONLINE AD REVENUES

Google has turned to artificial intelligence to protect its position as the dominant online search engine. Google currently account for more than 80% of online searches worldwide. This control of the market and its ad revenues helped parent company Alphabet generate earnings of $63bn in the fourth quarter of 2022. Microsoft recently announced a $10bn investment in the owners of the ChatGPT AI language engine which it hopes will help drive traffic to its Bing search engine. The stakes for Google are clear as shares initially rose 5% before falling more than 10% after criticism of the accuracy of the new technology.

Chinese tech firm Baidu is also looking to AI to secure its place as China’s dominant search engine. This week it announced it would launch its AI language engine Ernie Bot next month, helping its shares to rise around 15% this week. Meanwhile Apple is also developing an inhouse search function aided by its acquisition of AI firm Laserlike in 2019.