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How soft is soft?
With equity markets rebounding convincingly since their sharp sell-off in early August, the question remains are we still in a soft landing or is this a warning of something more troubling?
Weighing changes in the US labor market, we have seen a deterioration in employment and the July employment report has triggered the Sahm Rule.
Sahm rule triggered: Reliable recession indicator, albeit with four false positives
Source: Schroders Economics Group, Bureau of Labor Statistics, Congressional Budget Office, Macrobond, 2 August 2024
However, unemployment remains below the non-accelerating inflation rate of unemployment (NAIRU), and despite a rise off the lows, unemployment remains consistent with the pre-financial crisis low for now.
Unemployment remains below NAIRU
Source: LSEG, August 19, 2024
Unemployment rising steadily from here will increase the chances of a harder landing but the rise in unemployment appears to be driven more by an expanding labor force and strong migration than by rising layoffs.
Layoffs at historically low levels
Source: Schroders Economics Group, Bureau of Labor Statistics, Federal Reserve, Macrobond. 9 August 2024
Rise in unemployment rate was due to increased supply in the labor force and not permanent layoffs
Source: Schroders Economics Group, Bureau of Labor Statistics, Federal Reserve, Macrobond. 9 August 2024
It would be naïve to completely brush off the Sahm rule simply because it has been driven by labor supply but with unemployment still low in historical terms, layoffs not yet flashing amber and income growth healthy, we expect the consumer to remain resilient.
Consumer balance sheets deteriorating slowly
Source: Schroders, Macrobond, 13 August 2024.
Real income growth remains firm
Source: Schroders, Macrobond, 13 August 2024. Real wage growth is y/y change in average hourly earnings deflated by US headline CPI.
With US earnings on track for 10% growth in 2024, consensus expectations remain strong for 2025 and 2026. This provides support for equity markets, even as demand in China remains weak.
Consensus expectations are for strong earnings growth in 2025-26
Source: LSEG Datastream and Schroders Strategic Research Unit. Data to 7 August 2024. There is no guarantee forecast will be realized.
On the rate side, we acknowledge the aggressive repricing at front-end and therefore expect US steepener trades to pull back for the time being. Furthermore, at current levels, we believe there is some room in the short term for yields to move higher given our soft-landing view. Longer term, we expect that bonds - with inflation coming under control - will have an increasing role to play in portfolios to hedge against the recession risks. Over time, we also believe the normalisation of the yield curve should also help bonds to regain their attractiveness as growth diversifier.
US equity-bond correlation (weekly data)
Source: LSEG Datastream, as of 6 August 2024.
In summary, while we have been focused on navigating the risks over the last couple of weeks, we still firmly believe in the soft-landing scenario. Consistent with this view, we remain positive equity and we would favor using the aggressive pricing of rates cuts as a tactical opportunity to short duration at the front end. As most of our directional views are predicated on a soft-landing scenario, we see the value in diversifying by maintaining positions in Gold and the US dollar.
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