Is U.S. wage growth starting to slow?
On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Investment Strategy Analyst BeiChen Lin discussed the U.S. employment report for April and recent rate hikes by the U.S. Federal Reserve (Fed) and Bank of England (BoE). They also assessed the outlook for markets through the lens of cycle, valuation and sentiment.
U.S. job gains remain robust, while wage growth softens
Lin kicked off the segment by noting that the U.S. added 428,000 nonfarm payrolls during the month of April, continuing a nearly two-year trend of robust job gains for the nation’s labour market. Characterising the April employment report as healthy, Eitelman added that the gains were broad-based across multiple sectors of the economy, including hospitality, leisure and manufacturing.
Amid the highest inflation levels in decades, he said that a big focus for investors in the report was wage growth, which came in around consensus expectations. Average hourly pay increased by 5.5% in April on a year-over-year basis, which was both good news and bad news, Eitelman noted.
"On the positive side of the ledger, wage inflation isn’t accelerating anymore, and seems to be plateauing at a rate of around 5.5%. On the more negative side of things, this 5.5% figure is still too high for the Fed to durably reach its 2% inflation target," he stated. Ultimately, the April jobs report sends a message that the U.S. central bank still has more work to do as it seeks to combat inflation by increasing borrowing costs, Eitelman said.
Bank of England base rate rises to 1% after fourth consecutive hike
Zeroing in on rising interest rates, Eitelman noted that both the Fed and the BoE announced rate hikes the week of 2 May in their bids to tame inflation. The U.S. central bank lifted its key lending rate by 50 basis points (bps) at the conclusion of its 3-4 May meeting, he said, making for the largest rate increase in over two decades.
"Chair Jerome Powell indicated at the start of his post-meeting press conference that inflation is simply too high - and this really was the main driver behind the big hike," Eitelman stated, emphasising that the Fed is laser-focused on attempting to restore price stability.
He added that the Fed chair also effectively ruled out the idea of an even larger rate hike of 75 bps at the Federal Open Market Committee (FOMC)’s next meeting in mid-June, stating that such an increase was not under active consideration. However, Powell also strongly signalled that more 50-bps rate increases are in the cards - likely following the FOMC’s June and July meetings, Eitelman said. He noted that these remarks led to some wild swings in markets, with equity markets initially soaring on the news that 75-bps rate hikes were unlikely, before selling off in droves on 5 May as they digested the implications of a very hawkish Fed.
Meanwhile, at its 5 May meeting, the BoE hiked borrowing costs for the fourth consecutive time, lifting its benchmark interest rate to 1.0%, Eitelman said. The 25-bps increase comes on the heels of similar raises in both March and February, as well as an initial 15-bps hike last December, he noted.
Despite the series of rate hikes, BoE officials have become increasingly pessimistic about the outlook for the UK economy due to soaring energy prices, which could crimp consumer spending, Eitelman said. "The UK central bank is now projecting almost no economic growth from the fourth quarter of 2022 onward," he noted. However, the BoE is still discussing the need for future rate raises due to skyrocketing inflation, Eitelman added. "This sets up quite the delicate balancing act for the bank, with officials forecasting a potential recession yet still hiking rates. It will be interesting to see how much longer the BoE can pull this off," he remarked.
Assessing market volatility through cycle, valuation and sentiment
Switching to recent market performance, Lin said that the headwinds of central-bank tightening and mounting inflationary pressures rattled equity markets the first week of May, with the S&P 500® Index hovering near its low-point for the year as of midday Pacific time on 6 May. "The benchmark U.S. equity index is down more than 10% this year," he observed, adding that global markets are off about 13% in 2022, per the MSCI All Country World Index.
Eitelman noted that the downturn represents a fairly significant market correction, and said that market tensions are readily apparent when assessed through Russell Investments’ investing framework of cycle, valuation and sentiment. "On the one hand, the business cycle appears to be aging very fast as central banks raise rates and move closer to taking the punchbowl away. In short, this means recession risks are becoming a little bit more elevated, which could be a reason for investors to exercise more caution," he explained.
On the flip side, however, the selloff in markets has made asset-class valuations a little more attractive, Eitelman said. In addition, a look at market psychology and investor sentiment shows that some fear is starting to creep into the market, he remarked, explaining that this could lead to some opportunities to buy the dip.
"Ultimately, this sort of tension between cycle concerns and evidence of market fear suggests that the risks moving forward are pretty well-balanced. In this type of environment, we believe it makes the most sense for investors to focus on long-term plans and use their strategic asset allocation as an anchor to get through the volatility and uncertainty in financial markets," Eitelman concluded.