The tussle between “higher-for-longer rates eventually leading to a hard landing” and “cooling-inflation-without-a-recession (soft-landing)” narratives continues. While US job market and service sector activity remain resilient, Euro area and China data continue to underwhelm. The jump in oil prices to a 10-month high following Saudi Arabia and Russia’s extension of output cuts complicates the inflation outlook. Within a diversified foundation allocation, Standard Chartered’s Rajat Bhattarcharya advises looking to average into Developed Market (DM) government bonds, where the risk-reward trade-off remains compelling. Euro area government bonds look particularly appealing, given weakening economic fundamentals. Japan equities, ranking highest in the regional preference order, surged to a new 33-year high in USD terms.
Conflicting US data: The pace of US job creation continues to slow, with the previous two months’ payrolls revised lower. However, the US economy is still generating almost twice the number of jobs needed to keep the unemployment rate stable. A rise in labour force participation led to a jump in the jobless rate to 3.8%, but further gains in participation is likely to be limited. Meanwhile, US service sector business confidence, according to ISM PMI (which is biased towards larger companies and includes construction, mining, retail and the public sector, besides pure services) beat expectations, rising to 54.5. The rival S&P services PMI (which focuses purely on private service sector companies) was revised lower to 50.5, on the border between expansion and contraction.
The equity and bond market’s negative reaction to the strong ISM Services PMI data and oil price rise suggests investors saw “good news as bad news”. US rate expectations were revised higher and government bond yields approached their recent 16-year highs. The S&P500 index has once again broken below its 50DMA. Policymakers remained torn, with the Fed’s hawkish member, Waller, and Goolsbee signalling a pause in rates at the 20 September policy meeting, while Mester said inflation remains too high. SC expects the Fed to pause, especially if next week’s inflation data shows continued deceleration in core CPI (consensus: 4.3% y/y in August vs. 4.7% y/y in July).
Euro area risks rise: The Euro area’s outlook adds to the uncertainty. Europe’s Stoxx 600 equity index and EUR/USD both broke below their 200DMAs. The region faces stagflation risk, especially if oil continues to rise. Euro area growth is slowing sharply, as seen from contracting manufacturing and services PMIs and 11% y/y plunge in German factory orders. Yet, Euro area core inflation remains much higher than the US. Elevated inflation and a tight job market explain continued hawkishness among ECB policymakers in the face of a growth downturn – Lagarde, Knot and Kazimir signalled the possibility of another rate hike next week. We expect the ECB to stop after next week’s hike in the face of an evident growth slowdown.
China underwhelms: Supportive measures for the property sector and the CNY and Country Garden’s last-minute coupon payment helped to calm China’s USD bond market but appeared insufficient to revive equites or CNY. While oversold positions raise the chance of a near-term equity rebound, a more decisive stimulus is likely needed for a sustained rally.
Investment implications: The latest data raises the risk of a hard landing, especially if oil prices continue to rise, lifting rates and the USD in the near term. would use the current rise in DM government bond yields to average in as the bonds offer significant upside, and limited downside, in the event of a sharp slowdown in global growth. Euro area government bonds look attractive due to the region’s deteriorating growth outlook.
Japan equities remain compelling among global equities due to inexpensive valuations, positive earnings trends, higher dividends and record buybacks. The TOPIX index has surged to its highest level since 1990. Gold, traditionally an effective portfolio diversifier, is testing its 200DMA support around 1,918 –suggests to look to add exposure if this support level holds.
–Rajat Bhattacharya Standard Chartered
