Financial markets got off to a rip-roaring start to 2023. Equities, bonds and even bitcoin rallied in January. Emerging markets, shunned during the pandemic, also saw big inflows. The risk-on appetite hinged on expectations for a “soft landing” in the US: speedy disinflation, without a recession. Investors were brought back down to earth on Friday as the US reported strong job numbers, which raises the prospect that inflation could be stickier than expected and the Federal Reserve pushes interest rates higher for longer. Investors are befuddled. Until a clear narrative on how the economy will fare emerges, markets will continue to whipsaw.
Markets were initially buoyed by signs of easing price pressures in the US: headline inflation has been dropping from its highs since the summer and the Fed’s rate rises were beginning to cool interest rate-sensitive areas of the economy. Investors did not buy into the Fed’s narrative that monetary policy needed to do more heavy lifting before price growth would come under control. They had priced in a lower terminal rate and cuts later this year — even after the Fed raised rates by 25 basis points last week and warned of more to come.
After employment figures showed the US gained 517,000 jobs in January, much higher than anticipated, with unemployment at a 53-year low, markets moved closer to the Fed’s line and sold off. After all, solid jobs growth points to a still red-hot labour market, which will sustain price pressures. But markets are still digesting what it means for the US economic outlook, with a hard, a soft, and even a “no landing” scenario on the table, which have varying implications for investors and their positioning.