Weekly review 4 September 2023: Good labour market figures, bad industrial figures

6.9.2023

Overall, last week was positive for the equity markets. Stock prices rose throughout the week, led by the USA, until the data disclosures at the end of the week stabilised sentiment somewhat.

The week was also good for Finnish equities, which rose even faster than the global markets. Interest rates fell on both sides of the Atlantic but on Friday came back to the week’s starting levels in Europe. Oil prices continued to rise.

The ISM Manufacturing Index describes industrial development on a monthly level by tracking a very broad sample of US businesses. The index tracks, among other things, whether companies’ order intake is growing or declining, the volume of order intake of companies, and consumer prices. The index is measured on a scale of 1–100: when the figure is above 50, industry is faring better than average and when it is below 50, the outlook has weakened.

The manufacturing figures published by ISM on Friday revealed that, although the index rose slightly from the previous month, prices are on their way up. The conflicting picture painted by the index was negatively received in the markets.

A positive surprise from the US labour market

The labour market data published last week in the USA revealed that the unemployment rate had gone up to 3.8 per cent, against the expected 3.5. In addition, the volume of workforce had grown to almost 63 per cent of the working-age population. The markets received the data with delight, because a lower employment rate will go some way in easing the extremely tight situation in the labour market while at the same time also reducing inflationary pressures. The relationship between the labour market and inflation depends on wage development: when jobs are in scarce supply, employees have more negotiation power and wages rise faster on average. This, in turn, accelerates inflation, because employees have more money to spend.

There are at least two major factors behind the rising unemployment rate: the bankruptcy of Yellow, a large logistics company, and the Hollywood screenwriters’ strike. As a result of these, a total of almost 60,000 people exited the workforce.

There are three reasons why it is worth keeping an eye on the US labour market going forward:

  • Traditional economic theory suggests that there is a clear correlation between employment and inflation. When the labour market tightens, in other words, more working-age people are employed, inflation rises as wages go up.
  • Labour markets have behaved in an exceptional way in the post-Covid era, and demand for workforce has been very high.
  • The labour market is the thermometer of the economy. When growth slows, terminations increase and fewer jobs are created. That said, it is important to keep in mind that labour markets react to economic development with a slight lag.

Euro zone inflation nowhere near slowing down – stagflation?

The inflation figures in the euro zone remained practically flat compared to the previous month. Monthly core inflation, i.e. inflation less food and energy prices, remains above five per cent. At the same time, the car industry in Germany, a major economy, is struggling, and the euro zone economy as a whole may have some tough months ahead. If high inflation persists and economic growth remains negative, this leads to stagflation – a situation in which the economy does not grow but prices go up.

Especially oil and commodity prices are on the rise in the euro zone. Energy prices have a major impact on Europe’s industry, which is founded on cheap energy. This year, however, the situation if different from last year when it was uncertain whether there would be enough natural gas to heat the homes of the entire continent. The global gas market is sensitive, however, especially now that one of the largest operators has been removed from the market.

How should economic news be interpreted right now?

Rising and falling inflation, tight labour market, rapid economic growth in the USA. How should the news be interpreted and what do the various economic and inflation figures mean for investors in the current situation?

In a so-called normal situation, accelerating economic growth and an inflation rate of around two per cent create an ideal economic environment from an investor’s perspective. Now we are in a situation where inflation is clearly above the target and economic growth is slow in Europe and rapid in the USA. That is why the usual guidelines for interpreting the markets are not applicable right now.

The ideal scenario at the moment would be inflation taking a clear downward turn with economic growth simultaneously even slower than average. Were the economy to grow too fast, it could overheat and accelerate inflation further. In that case, the central banks would tighten their monetary policy, thus weakening the conditions for economic growth in line with the target.

The worst-case scenario, however, would be nil or negative economic growth and accelerating inflation. That is why it is worth keeping a close eye on the euro zone’s figures over the next few months.

 

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