The announcement this morning that the Turkish military shot down a Russian plane near the Syrian border rippled through financial markets with gold and safe-harbor sovereign bonds rising and European equities selling off modestly with most primary indexes off by more than 1 percent. In recent months, markets have not had pronounced reaction to geopolitical risk factors, but the rapidly deteriorating situation in the Middle East and the resulting refugee crisis now threaten to undermine confidence as investors plot year-end allocation decisions. One factor that has buoyed sentiment to date has been a much-better-than-anticipated earnings cycle with roughly 75 percent of Standard & Poor’s 500 components beating analyst targets, albeit after multiple downward revisions. The question now is whether the “better than bad” results from U.S. and European companies can outweigh fears of escalating conflict.
BOE to keep rates at historic lows. In testimony before parliament today, Bank of England Governor Mark Carney reiterated that there was no pressing need to raise benchmark rates in the near term. The central bank’s chief policymaker has cited continued low inflation and the potential effect of a rising pound versus the euro as dominant factors in the bank’s process.
Tilton managed fund files chapter 11. On Monday, New York’s Patriarch Partners announced that it will seek bankruptcy protection for one of its credit funds after failing to secure an extension with a primary lender, MBIA. The news arrives as Patriarch and controversial founder Lynn Tilton face investor lawsuits and Securities and Exchange Commission allegations of fraud.
Tiffany’s earnings miss forecasts. Third quarter results released by iconic luxury retailer Tiffany & Co. fell short of analyst expectations with sales rising by 1 percent versus the same period last year for per share earnings of $0.70. In accompanying statements, management indicated that a strong U.S. dollar was a primary driver for the disappointing returns.
Improving corporate sentiment in Germany. Data released by the Ifo Institute today indicated an improving mood among German executives as macro headwinds are offset by expectations for increased European Central Bank easing measures. The headline expectations index rose to 104.7 versus 103.9 in October.
US GDP improves. Revised gross domestic product data released this morning by the Commerce Department improved to an annualized pace of 2.1 percent versus the initially estimated 1.5 percent. Although gains in wages and inexpensive fuel costs have helped the situation for households to improve economists note that extended inventory levels may weigh on the corporate sector contribution to growth in the final three months of the year.
Portfolio Perspective: The Link Between Inflation and Labor Market
The link between inflation and the labor market has cracked. This makes life challenging for anyone trying to formulate a 360-degree view of the relationship between monetary policy and economic outcomes (not to mention financial markets). Market participants should expect more uncertainty in terms of both monetary policy decisions and the effects of those decisions.
Whether the breakdown in the relationship between wages and inflation represents a temporary crack or a fatal breach remains anyone’s guess. Perhaps, as in the case of the Phillips Curve, some might argue that the relationship existed only in theory but not in practice. Such a debate would fit better in an academic seminar than a market commentary.
There are other, more relevant, implications for market participants: Where once policy makers and market observers could reliably lean on wage and other labor market data to guide or inform future U.S. monetary policy, greater uncertainty may now exist. The Federal Reserve’s Federal Open Market Committee has repeatedly signalled that a reduction in labor market “slack” (i.e., an increase in labor demand that likely translates into higher wages) would provide the impetus to lift its targeted fed-funds rates during 2015. Then what? Will the Fed continue to hike interest rates to ward off future inflation if the labor market tightens, or will inflation not respond to changes in labor market slack? The significance of this question extends beyond those trying to time Fed decisions. Since the long-term path of interest rates matters more for long-term economic growth and inflation than the date of the initial liftoff, the answer to this question matters to anyone trying to forecast economic states.
Jeff Saret, Senior Vice President of Thematic Research and Subhadeep Mitra, Research at Two Sigma Investments in New York.
