The immovable market

• US unit labour cost rises for Q2 came in above 10% for the second quarter in a row.
• Westpac consumer confidence for August is down by 3%.
• Key US and European inflation data is out later today – what will it take to shift the market from this tight trading range?

High prices remain

US unit labour costs for Q2 2022 were 10.8% higher than the previous quarter on an annualised basis, and above 10% on this data point release for the second quarter in a row.

Higher wages hurt company profits, resulting in a net operating profit decline and threatening their ability to hire and keep the economy moving.

A stitch in time

The Federal Reserve might raise rates in response to high wage inflation, increasing the costs of accessing debt and in turn a company’s cost of capital.

Capital funding rounds intended for expansion and hiring may be deferred, with only the most profitable opportunities getting funded and a few of the more marginal falling by the wayside.

Slowing and even retreating hiring is one of the intended consequences of a policymaker’s rate rise. While degenerative to the economy in the short term, it is designed to ensure that a nation’s people don’t get so flush with cash that all prices rise untethered and irreversibly harm the most vulnerable.

The forward-looking market

The financial markets anticipate events before they happen if the parameters have already been set. When economic data suggests that wages are rising very quickly relative to the past, a rise in the probability of interest rates higher than in the recent past will most likely be reflected in the markets.

When interest rates rise, unless the inflation is running too fast for the policymaker to catch up, the most likely market response is for the currency to appreciate as cash saving becomes more profitable relative to investing and spending.

It may then be somewhat surprising because as we continue to see high labour cost prints, the US dollar is actually tracking sideways.

The six-month US dollar index chart

There are two possibilities here:

1. We have reached a top in the inflation cycle and may be turning the corner, leaving the door open for policymakers to start slowing rate hikes.
2. The more worrying of the two possibilities is that the US Federal Reserve is too far behind the curve and the US dollar is slipping as a result, requiring a more aggressive rate hike approach.

A soft landing in sight?

Data from around the world and the recent trajectory down in the oil price lean toward the first possibility playing out right now.

The Chinese print on inflation through to the end of July was released today by the National Bureau of Statistics. The zero-COVID approach continues to have a positive impact on the populace’s back pocket. Year-over-year inflation for the month of July retreated to a more manageable 4.2% from the expected 8%.

The National Australia Bank (NAB) business conditions index for July is hovering around the highs since the data started being collected. Although not closely followed by the wider market as it’s too narrow a view to mirror the market’s movements, the print does suggest that businesses will continue to hire in Australia.

Australia

The S&P/ASX 200 index has been moving sideways over the last two weeks, hemmed in by high inflation and rising borrowing costs, while at the same time experiencing high employment and businesses benefiting from a cashed-up consumer.

If the global raw material and labour supply have commenced a rebalancing cycle with prices moving to a more moderate stage of growth, then it is possible that international monetary policymakers can start to think about slowing down the rate hikes and more jobs can be sheltered.

It is too early to say in which direction we’ll go, but there are signs that we might be able to turn this corner without too much collateral damage and that the economy continues to stay the course for now.