By Geraldine Sundstrom, Asset Allocation Portfolio Manager, PIMCO
Last week was busy with a chorus of Fed speakers all talking the same talk: inflation is unacceptably high and the Fed is going to take action as soon as March, with the unwinding of the balance sheet not far behind. The mood has clearly turned and this transition is creating quite a bit of volatility in markets overall. By now markets are roughly pricing four rate hikes by the Fed in 2022 and there is broad consensus that the balance sheet will start to be unwound in H2 2022.
To add fuel to the fire, the U.S. inflation print revealed an inflation rate unmatched since 1982 with the headline at +7% year-on-year (yoy) and core at +5.4% yoy. But this could turn out to be the last resurgence of the reopening boom given that things are certainly slowing. For sure, the Fed and the U.S. consumer price index (CPI) print stole the show but our attention has turned elsewhere.
Inflation is starting to surprise to the downside in a number of emerging markets, not least in China and India. Inflation in China has collapsed to +1.5% yoy vs. +2.3% yoy the prior month and surprised negatively by two-tenths. The Chinese producer price index (PPI) remains elevated at +10.3% yoy but there again it was a full percent below expectations, while the U.S. PPI and the import price index were also mildly below expectations. This could potentially mark the beginning of better times ahead at last, if the Omicron wave doesn’t conspire against normalisation once again.
But there are other clear signs of slowdown among consumers in particular. U.S. December retail sales figures were quite weak, with the control group measure at -3.1% month-on-month (mom) against expectations of a flat number. For sure, some of the holiday shopping was front-loaded earlier in the season, but the issues seem to run deeper. The fiscal handouts are drying up and the income of many households is taking a hit, in particular as the monthly expanded child tax credit has now stopped and inflation has made the buying climate far less attractive. The U.S. Langer consumer confidence index has fallen to its lowest level in 18 months, and the buying climate has witnessed its largest decline in 36 years at 29.5/100. The University of Michigan consumer sentiment index confirmed this trend and came in well under expectations too – 33% reported personal finances worse than one year ago, the worst since 2014.
Finally, as the earnings season just started in the U.S., the number one headline-grabbing item is labour costs and wage inflation that are running at two to three times the old pace, putting a dent in the profits of the businesses most exposed. One corollary is that some automated warehouse solutions providers suggest that the time to repay a fully robotised warehouse versus operating a regular human-powered one has collapsed to just eight months, driven by labour costs.
These are, in our view, the first tangible signs that the economic expansion is maturing and reaching the mid to late point. The areas of structural growth and demand are likely to fare better than the pure cyclical sectors going forward. The great moderation was always on the cards and growth will become scarcer again in the quarters ahead as central banks globally hike in unison.