One of the biggest indicators confounding markets, economists, and commentators over the past six months in particular, is the strength of the employment market. Not only are they stable, they are moving at rates outside historical ten year norms. Just have a look at Australia at the moment, unemployment at 4% averaging 35 to 40,000 jobs per month and participation in the employment market at or near record all-time highs.
This is not just an Australia story, have a look at the US where the non-farm payroll figures continue to run ahead of our expectations and forecasts. Yes it is eased from its peak in 2023/2024 but overall The US employment market is really solid. This is despite the fact that the cost of living crisis is entering its 28th month and according to all media factions is still ‘ending the world’.
The thing is - employment stability produces stronger than anticipated consumer spending. And we believe that this is what's being missed by traders and investors alike as the stability has directly supported stronger-than-anticipated consumer spending. Which in turn for western developed markets underscores why there has been resilience of the economy.
That's not to say a slowdown in economic growth is off the cards, more that the trajectory looks less steep and more delayed than previously forecasted. Retail sales data for December showed a solid 0.7% month-on-month (MoM) increase. Which suggests real consumption growth for the final quarter of 2024 was a year on year (YoY) 3%.
As long as the labour market remains resilient and equity prices avoid a sharp downturn, consumer spending should continue to hold up. Caveat is US savings rates, they are now at the lowest level in over 6 years so expect spending growth to moderate in the coming months. Something that was seen in 23/24 was weaker retail sales in Q1 of last year after a bumper December print - could repeat in 2025 following the strong December retail performance?
But you are probably thinking “who cares” what does this mean for my trades and what does this mean for my positioning? Well as explained in last week’s 5 thematics of 2025 - nationalism versus global trade supply is one area we need to look at. Because it will feed directly into the theme that has been going on now for 18 months which is the consumer price conundrum.
Why this matters markets have put so much money behind the rate cut trade impacts both positively and negatively to inflation will still be one of the biggest impactors to your trades. So looking to the US let's break down the December CPI data – there was a modest 0.23% MoM increase, for a YoY rate of 2.7%. Aligning with the 0.17% MoM rise in core Personal Consumption Expenditures (PCE), which and a YoY rate of 2.1%.
This effectively confirms the Fed’s inflation target has been hit. Think about that for one moment and the initial reactions in the market to start 2025. It was rift with bets that the Fed could be done, and that inflation would remain stubbornly high.
There is justification for this idea and more on that below. The December CPI suggests US core inflation to trend down to about 2% by mid-year. Secondly the trend is there as well - three-month core inflation has slowed to 2.2%, and six-month core inflation has eased to 2.3%.
These figures point to a clear and sustained moderation in price pressures. Going deeper – the biggest factor that is likely to drive US inflation lower is signs shelter costs have peaked and are beginning to ease. Owner’s Equivalent Rent rose just 0.23% in November and 0.31% in December.
These increases are much slower than the 0.4-0.5% monthly jumps seen in late 2023 and are more in line with pre-pandemic norms. Of course, there are caveats to this narrative. Residual seasonality in the data could skew the inflation readings.
For example, in both 2023 and 2024, softer inflation in the latter half of the year was followed by a sharp 0.5% MoM spike in core PCE inflation in January. But – if the November December trend in PCE inflation was to continue in February and March it would reinforce confidence among both the Fed and markets that inflation is on a sustainable path back to the central bank’s 2% target – and that should equal more rate cuts in the Federal Funds Rate. All things being equal - by the time the Federal Open Market Committee (FOMC) meets in May, there would likely be enough evidence to justify this move, especially to prevent real policy rates from rising unintentionally as nominal rates hold steady.
However – there are input costs coming from the newly installed Trump administration. Changes to immigration policy is likely to drive up wage and input cost on sectors such as agriculture and personal services. Then there are possible tariffs and other trade sanction issues that will also impact global supply and ultimately price.
If we look at the chatter from Fed officials, opinions vary on the implications of broader policy shifts. Hawkish members of the Fed expect these policies to exert upward pressure on inflation, while dovish officials, argue that any price increases stemming from these factors would likely be temporary and wouldn’t necessitate a monetary policy response. Either way – they are unknown knowns, and explains the flow of funds to the USD, CHF and gold.
It also probably explains further excitement in crypto. So – who is right and who is wrong? If we take the movement in the USD and bond markets as ‘right’ – inflation is going to move higher from here and the Fed is done.
Traders only now have moved from possible rate hike(s) – (yes higher) to a mild chance of a single rate cut in 2025. The Fed’s December dot plots – only has 50 basis points – so two cuts, which is not huge and explains the shifts. On the counter – if the current market trend is wrong we need to look at the economist forecast.
Most have 3 rate cuts in 2025 some have as much as 5 (so 125 basis points). If that was to be the case the speed and change in positioning will be rapid and the strength in the USD would need to be evaluated. That scenario, if it eventuates, would likely begin in May, there is plenty of time to reposition.
But risks remain, particularly around seasonality and policy uncertainties. In the interim, watch for fiscal policy around nationalism then look for changes in inflation and labour that lead to monetary policy changes in the coming months to maintain balance in the economy.
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