Through early August’s market dislocation, the Fed’s capacity to significantly ease policy was our main reason to stay invested in a moderately pro-risk diversified allocation. The continued softening of US inflation in July provided another signal for the Fed to start easing policy from September, while strong retail sales boosted hopes for an economic soft landing. This, and the near-exhaustion of unwinding of JPY-funded carry trades, has helped risk assets recover from the recent shakeout.
However, Standard Chartered in its analysisi said since its technical model still points to near-term risk for US and Japan equities, it would prefer to average in only gradually. The house still prefers US growth equities due to their structural earnings growth outlook. SC said it sees downside risk for the NZD after the central bank’s surprise rate cut this week.
Cooling inflation: US inflation continued to cool in July, helping revive risk sentiment. On a three-month annualised basis, core and supercore inflation (services inflation excluding food, energy and shelter) have fallen below the Fed’s 2% overall inflation target. Although shelter inflation rose to 0.4% m/m from 0.2% in June, accounting for most of July’s 0.2% m/m inflation, and auto insurance accelerated, falling market rents and a slowing job market portend lower official shelter inflation in the coming months. Also, the sharp drop in used car prices points to lower auto insurance inflation later this year.
Jackson Hole summit watch: Cooling inflation and the surprisingly weaker-than-expected monthly employment report for July have turned the spotlight on the Fed’s annual Jackson Hole summit (22-24 August). While markets are pricing almost 100bps of rate cuts this year and a total of almost 180bps of cuts in the next 12 months, they have dialled back the expected size of the first rate cut in September to 25bps, after earlier pricing in a 50bps cut. Fed policymakers will get a chance to push back against
such aggressive rate cut expectations, which in turn could drive the US 10-year government bond yield above 4%. On the other hand, support for more aggressive cuts could drive yields towards early August’s closing low just below 3.8%. SC said it sees low chances of the latter happening in the near term unless the job market cracks and weekly jobless claims surge. It also believes investors have an opportunity to lock in high quality US government bonds for the longer term at 10-year yields of 4% or higher as the US economy gradually slows.
US growth sectors still preferred: The house believes the high-growth technology and communication services sectors remain attractive relative to other US sectors, especially because of the sectors’ strong structural earnings growth potential. For instance, the LSEG I/B/E/S consensus expects 18% and 21% growth in technology sector earnings in 2024 and 2025. The growth sector-heavy Nasdaq index also has strong technical support around 18,000, providing a base to add exposure. It also sees near-term opportunity in Japan banks.
Near-term caution on equities: Its technical model remains bearish on US equities in the near term. Volatility is the key market variable to watch. Average S&P500 index realised and implied volatility has fallen to 2 standard deviations (SD) above its one-year average, from 4.6 SDs on 5 Aug (the height of the sell-off), suggesting the spike in implied volatility was overdone. Assuming the current pace of decline in overall volatility and momentum does not worsen, it should take another week or so for volatility to return to levels that would support an uptrend regime for equities once again. Hence, the bank said it would prefer to gradually average into US equity markets, at least for now.
Maintain geopolitical risk hedges: There is a risk of a near-term escalation in tensions in the Middle East and along the Russia-Ukraine border. Although geopolitical risks have historically had a short-term impact on markets, benchmark allocations to gold and energy-related assets offer hedges in the event of any widespread supply dislocations
