To The Moon

By originally labelling inflation as a temporary phenomenon, central bankers were too late in combating it. That was compensated with rapid, sharp interest rate hikes, which the economy will only feel in full next year. Part of that late intervention is that central bankers today do not dare to look ahead, relying instead on two ‘lagging’ indicators: inflation and unemployment. These indicators, by definition, look backward and not forward.

As a result, central bankers would rather be late than early in cutting interest rates. That does make the job easy for those who dare to look ahead. As a result, a year ago, predicting inflation would fall throughout 2023 was relatively easy, and inflation will continue to fall for the next 12 months based on the forecasting indicators. Unemployment remained low for a long time due to the tight labour market, but now there are enough figures to state with conviction that it will continue to rise here, too. With this, arguments no longer favour the ‘longer high’ policy. That policy did ensure that the market hardly dares to consider interest rate cuts next year. That is a prelude to positive surprises next year.

Soft landing thanks to the labour market

Last year, government investment and tax cuts, on the one hand, combined with low unemployment on the other, helped avoid a recession in the US. Consumers comprise two-thirds of the economy and continue to spend as long as there is near-full employment. That has created the economically favourable scenario of a soft landing, which for the stock market has the adverse effect of keeping interest rates high for longer. With that comes higher investment and possible interest rate cuts next year. With that, the chances of a recession are lower, but there is less upward pressure on wages.

Unemployment rising

Unemployment is rising in both Europe and the United States. In Germany, unemployment is at its highest level since June 2021. Germany’s unemployment rate is still relatively low, but last week in France, unemployment rose for the second month. There, unemployment stands at 7.2 per cent, still well above the French government’s 5 per cent target. Across the eurozone, unemployment is rising, albeit from an all-time low. In the United States, the rule of thumb is often used: when unemployment increases by half a per cent, a recession is inevitable. The lowest point in the United States was at a rate of 3.4 per cent, which has since risen to 3.9 per cent. That is low by historical standards, but unemployment is always ahead of a recession.

Higher jobless claims

The United States has different ways of looking at the labour market. One is a monthly jobs report published simultaneously with the unemployment figures. In both cases, they are samples with the necessary statistical noise. Looking at the long-term trend rather than the monthly figure is better. Many economists prefer to look at initial jobless claims. These new applications for unemployment benefits are published weekly. Besides initial jobless claims, there are also continuing jobless claims. Initial claims have risen to the highest since August, and continuing claims are now at the highest level in the past two years. Together with other labour market data, this indicates an evident cooling.

Continued year-end rally

The unemployment figures may contain one-off effects such as the carmakers’ strike or the possible US government debt ceiling shutdown. Still, those factors should have a positive rather than a negative impact on claims for unemployment benefits. With this development, there is even more certainty that the peak in interest rates is behind us and that we should look forward to probably more rate cuts than the market is currently counting on. This is positive for both equities and bonds in 2024, but as so often happens, the stock market is already anticipating this good news via the year-end rally.