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“Chickens coming home to roost” is an idiom that’s been on my mind lately – the idea that your actions will ultimately come back to you. I look at it in parenting terms; how children are raised will be reflected in who they become. For example, my mom helped care for my children when they were little, and she was a “neat freak” who constantly cleaned. Not surprisingly, my oldest quickly became obsessed with cleaning. He stored Windex and paper towels in his toy box, and would wipe restaurant windows with his napkin. Because of my mom’s influence, we had a very clean little chicken roosting in our home.
I can’t help but think of that saying in economic terms as well. After aggressive monetary policy tightening by some central banks, we’re waiting for those chickens to come home to roost. There are differing opinions on what those chickens (both the “inflation chickens” and the “growth chickens”) will look like – and markets can get nervous about unexpected consequences.
In the U.S., a “good news is bad news” narrative took hold a couple of weeks ago with positive economic data spurring fears that the Federal Reserve (Fed) will feel the need to hike rates further:
However, other data suggest the U.S. economy is cooling:
Anecdotal information found in the most recent Federal Reserve Beige Book also indicates that U.S. economic growth was modest this summer. There was selective consumer spending in areas like travel, but other retail spending continued to moderate, especially non-essential retail spending.
Some of those interviewed for the Beige Book even articulated concerns that household savings are being exhausted and consumers are borrowing in order to support spending – most Federal Reserve districts reported that consumer loan balances are increasing, and so are consumer credit line delinquencies.
My views on the labour market were supported by the Beige Book. Job growth was reported to be subdued across the nation. More importantly, nearly all districts expect wage growth will slow in the near term. And my view that overall inflation will continue to moderate, albeit imperfectly, was also supported by the Beige Book. Most districts reported price growth eased, with greater deceleration in the manufacturing and consumer goods sectors.
Now all is not rosy. Not surprisingly given recent headlines, several districts reported very significant increases in property insurance costs. It is also worth noting that a few districts reported input price growth did not drop as much as selling prices, which led to a narrowing of profit margins in those districts.
And then there is the potential for a United Auto Workers strike, which could threaten to temporarily exert upward pressure on inflation by disrupting supply chains – and could have a bigger impact on already-jittery markets.
The reality is that central banks are largely flying with blindfolds on because of the lagged effects of monetary policy. In channeling his inner Lord Byron at Jackson Hole, Fed Chair Jay Powell eloquently explained, “We are navigating by the stars under cloudy skies.”
Because of this uncertainty, markets are quick to react to individual data points without taking a step back to look at the bigger picture for the U.S., which is one of economic slowing and disinflation. They are making assumptions about their returning chickens based on a few data points.
I think it’s important to pay attention to a study published last week by Chicago Fed economists.5 Their model indicates that the tightening that has already occurred is sufficient to bring inflation back near the Fed’s target by mid-2024 – and without bringing about a recession.
I agree with that assessment, including that the U.S. can avoid a recession (although as I’ve said many a time, including last week, it will be a bumpy landing). Those are chickens that will be welcomed back to the nest with open arms if they return.
There is also a lack of clarity around what chickens will come home to roost in Canada as a result of its aggressive monetary policy tightening. Because of that, the Bank of Canada (BOC) erred on the side of caution and enacted another pause on tightening on Sept. 6.
However, BOC Governor Tiff Macklem talked tough in a speech, suggesting rates may not be high enough. This was a perfect segue to the Sept. 8 release of the jobs report for Canada, which showed far more jobs created in August than expected.
Macklem, like Powell, needs to talk tough to help keep a lid on inflation. However, I suspect Canada will not have to tighten again. Their chickens will likely look similar to the ones in the U.S.
In short, central banks continue to have an outsized impact on markets because of the lagged effects their policies are having on their respective economies. That impacts currency markets, bond markets, and equity markets.
Because growth is improving and the odds of a recession are decreasing for the U.S. economy, I believe we are likely to see stronger near-term performance of cyclical sectors such as industrials, materials, and energy, as well as smaller-cap stocks. That’s especially so if the very important core U.S. Consumer Price Index print later this week supports the disinflation narrative.
While Europe and the UK have had more growth headwinds, cyclicals and smaller-caps could perform well in these regions – especially if growth starts to improve. In addition, valuations are far more attractive for European and UK equities. A weakening U.S. dollar should also be a positive driver for international equities – especially emerging markets, many of which have been benefiting from a positive macroeconomic backdrop.
In fixed income, “risk on” asset classes such as U.S. high yield, bank loans, and emerging markets hard currency debt look attractive given the favourable macroeconomic backdrop and their higher relative yields.
Having said all that, there could be more data points that trigger the kind of market behaviour we’ve seen recently, with long Treasury yields rising and depressing equities. It is to be expected that there will be some days when markets reflect uncertainty about which chickens are coming home to roost.
Kristina Hooper is Chief Global Market Strategist at Invesco.
Notes
1. Source: US Bureau of Labor Statistics, Sept. 7, 2023.
2. Source: Institute for Supply Management, Sept. 6, 2023.
3. Source: S&P Global, Sept. 2023.
4. Source: JOLTS Report, Bureau of Labor Statistics, August 29, 2023.
5. Source: Chicago Fed Letter, No. 483, “Past and Future Effects of the Recent Monetary Policy Tightening” by Stefania D’Amico and Thomas King, Sept. 2023.
Disclaimer
© 2023 by Invesco Canada. Reprinted with permission.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
The opinions referenced above are those of the author as of August 21, 2023. These comments should not be construed as recommendations, but as an illustration of broader themes. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
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Diversification does not guarantee a profit or eliminate the risk of loss.
All figures are in U.S. dollars.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
All investing involves risk, including the risk of loss.
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