Strategy & economics
A ‘goldilocks’ labour market suggests further legs in the business cycle
Global Economist, Janet Mui, reviews the latest US nonfarm payroll report
Global economic data continues to signal a favourable macro backdrop, with the global composite purchasing managers’ survey (PMI) picking up to a near three-and-a-half-year high in February. Consensus global growth forecasts for 2018 continued to be upgraded, lifted particularly by the US due to Trump’s tax cuts and the US$ 300 billion additional spending plan. Inflationary pressure continues to rise but has remained contained.
The most recent release of the US inflation and labour market report paint a ‘goldilocks’ backdrop for markets. US headline consumer price index (CPI) and core CPI were in line with estimates in February, with the former picking up from +2.1% year on year ( YoY) to +2.2%, while core CPI remained steady at +1.8% YoY for the third consecutive month. Looking at the details, heavy components such as rent and medical services show no sign of significant pick ups. Given the later stage of the cycle in the US, stronger growth is expected to increase inflationary pressure. However, recent data still paints a picture of a gradual rise of inflation but no sign of overheating.
The latest nonfarm payroll report saw a downward revision of the strong wage growth in January which spooked the markets, while the February figure disappointed. Despite the robust job creation, the unemployment rate remained at a 17-year low of 4.1% for the fifth consecutive month as the supply of labour increased noticeably in February. An interesting feature of the nonfarm payroll report was that the labour participation rate picked up from 62.7% to 63.0%, revealing some degree of slack in the labour market, which may have prevented further wage pressure. This suggests that the Federal Reserve is under no immediate pressure to aggressively raise its interest rate projections.
What are the market implications? Global equity markets have enjoyed an extended rally since 2009, with some concerns increasing about its sustainability. Indeed, the uneasiness surrounding inflation and the rapid increase in bond yields led to a knee-jerk sell-off in riskier assets in February. We think robust and broad-based global growth with modest inflation present a ‘goldilocks’ backdrop for equities. Our analysis shows equities tend to perform well when US inflation is between 1% to 3%, an environment we expect to see throughout 2018 and potentially into 2019, with US CPI below 3%. A flatter Philips curve (the inverse relationship between unemployment rate and wages) post-crisis suggests that while wage growth is set to rise due to a tightening labour market, the pace and extent of it has become more modest compared to the previous cycle. Historically, the stock market peak coincided with the US unemployment rate converging with wage growth at around 4% YoY. With wage growth currently at 2.6% YoY, we still have a long way to go.
Janet Mui, CFA is the global economist at Cazenove Capital, the wealth management division of Schroders. Janet is responsible for the formulation and communication of Cazenove’s top-down views. She is a member of the investment committee that oversees strategic and tactical asset allocation at Cazenove. Janet is also the macro spokesperson and a regular commentator at major media outlets including the BBC, Bloomberg and CNBC.
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