Monthly House View - October 2024 - Download here 

Over the summer, market sentiment around the US economy grew increasingly cautious. A poor US employment report, an unexpected 15 basis point (bps) rate hike by the Bank of Japan, and light summer trading created a “butterfly effect” in financial markets. However, by the time investors returned from their summer holidays, most equity markets had fully recovered. We maintained our position during this period, adhering to our soft landing outlook, but we remain vigilant.

COOLING BUT NOT COLD

Despite concerns, macroeconomic data has not signaled the kind of weakness that would suggest an impending recession. Retail sales continue to demonstrate the resilience of the US consumer, with Q2 GDP growth at 3% and Q3 tracking similarly. The focus, however, has shifted to the labour market. While the July jobs report was concerning, August’s data showed improvement, though it fell short of expectations. The labour market is clearly softening: hiring has slowed, but layoffs remain limited. This normalisation offers some reassurance. Notably, the “Sahm Rule,” which has accurately predicted past recessions, recently triggered a recession signal. Yet even Claudia Sahm herself has cautioned against over-reliance on historical patterns, stressing the need for a nuanced approach. The job market is certainly weaker; new workers are entering, which is a positive sign, even if it takes them time to find employment.

THE FED’S DUAL MANDATE

Concerns over a potential halt in disinflation are now largely behind us, with US inflation down to 2.5%. This allowed Fed Chair Powell to open the door to rate cuts in August, which were realised with a significant 50 bps cut at the September FOMC meeting. The message is now clear: the Fed has shifted its focus from protecting the US consumer from inflation, to protecting employment. In its dual mandate “pursuing the economic goals of maximum employment and price stability”, employment is now the priority. With price stability largely achieved, the Fed’s goal is to safeguard jobs. This recent rate cut, the first in more than four years, is intended to pre-empt any significant economic slowdown. As Powell stated, “The US economy is in a good place, and our decision today is designed to keep it there.” In light of this, we have revised our Fed forecasts, now anticipating the Fed Funds rate to fall to 3.5% by the end of 2025, which includes two additional cuts than previously expected. For the European Central Bank (ECB), we have adjusted our outlook, now projecting rates to reach 2% by the end of 2025, down from 2.5%.

FROM MACROECONOMICS TO POLITICS

Looking ahead, macroeconomic factors will remain front and center for investors. Seasonality is typically unfavorable in the lead-up to US elections, where the race is expected to be much tighter than anticipated. As always, the outcome is difficult to predict, with the final result hinging on the so-called seven swing states rather than the popular vote.
Investor positioning remains cautious on equities. Retail investors seized the August dip to increase equity exposure, but institutional investors have held back. We remain optimistic about equities for now, given our continued belief in a soft landing scenario and undemanding earnings expectations going into the Q3 season. However, we are also aware of the uncertainties ahead and are proceeding with caution.
On the bonds front, we are more perplexed by the sharp decline in the US bond market. In just four months, 10-year US Treasury yields have dropped from 4.7% to 3.6% on recession fears, while equities remain near their highs. Which market is right? Concerns over US debt sustainability have faded, yet currently over USD 1 trillion is added to the debt pile every 100 days, ultimately pushing the total to more than USD 35 trillion. Given this backdrop, we have adopted a more cautious stance on duration and are avoiding the long end of the bond market for now.

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