Insights

US Economy’s Progress Towards a “Soft Landing” Narrative

Macro Events

On October 17, 2024, the European Central Bank (“ECB”) announced a significant adjustment, reducing its key interest rate to 3.25% [1]. This marks the ECB’s third quarter-point cut this year and represents its first consecutive rate reduction in over a decade [2]. Amid indications that inflation across the eurozone is increasingly under control, the central bank’s priorities have shifted toward sustaining economic growth as the region faces a deteriorating economic outlook and growth has lagged behind that of United States for two years straight.

In the U.S., expectations surrounding the pace of rate cuts have shifted markedly in recent weeks. Stronger-than-anticipated employment data has led markets to temper the likelihood of another bold 50-basis-point rate cut by the Federal Reserve, a move that was implemented at its September meeting. The latest data suggests the labour market remains more resilient than previously thought, with nonfarm payrolls growing by 254,000 in September—significantly outpacing the consensus forecast of 150,000 [3]. Additionally, revisions to the prior two months added 72,000 jobs, pushing the three-month average payroll increase to 186,000, a robust figure that appears well-suited to meet labour supply growth [4].

In a further indication of strength, the unemployment rate edged down to 4.1%, a 0.1 percentage point drop [5]. This sustained labour market momentum has prompted markets to recalibrate their rate cut expectations. According to the CME FedWatch data as of October 28, 2024, the probability of a 50-basis-point rate cut has plummeted to 0%, down sharply from 53.3% a month ago. Conversely, there is now a 5.2% implied probability that the Fed will hold rates steady at the upcoming policy meeting—a notable shift from 0% just a month prior [6].

Views on Equities

The third-quarter earnings season kicked off in October with a strong start, as major U.S. banks, traditionally among the first to report, exceeded consensus expectations across the board. Notably, as per the public data in this regard, we note that the major investment banks delivered standout results, buoyed by robust fee income and trading activity. Goldman Sachs reported a 20% year-over-year increase in investment banking fees, while Bank of America posted its highest third-quarter trading revenue on record [7]. Citigroup also impressed, achieving its strongest third-quarter trading performance in over a decade.

We believe these solid earnings from U.S. banks reflect the resilience of the financial sector amid high interest rates. The reported robust earnings, alongside recent labour market data, may point toward an increasingly optimistic economic outlook, potentially indicating a “soft landing” or even a “no landing” scenario, one in which growth remains steady and resilient. This positive backdrop may be further bolstered by the initiation of a globally synchronized cycle of interest rate cuts that had already started in September, which is expected to ease consumer burdens and alleviate some of the pressures on valuations going forward. As a result, we believe the investment environment in the U.S. remains fundamentally constructive and maintain overweight in US equities.

Moving to Asia, on 12 October, China’s Ministry of Finance (MoF) confirmed plans to support indebted local governments, recapitalize large state banks, and stabilize the property market [8]. While no concrete numerical fiscal stimulus target was set, the MoF did reinforce China’s new accommodative policy tone. We maintain our positive outlook on China/HK equities, having renewed confidence in the region’s recovery potential. Despite the recent rally, valuations of major equity indices in China and Hong Kong, such as the CSI 300 and Hang Seng Index, currently trade at significantly lower multiples compared to other global benchmarks. The CSI 300 and HSI have 12-month forward price-to-earnings (P/E) ratios of 12.52 and 9.15, respectively, which stand in stark contrast to the higher valuations seen in the S&P 500 and Nikkei, both trading at forward P/E multiples of 20.84 and 19.44. This substantial valuation gap may present a compelling opportunity for potential re-rating. With lower multiples, Chinese equities may offer more room for upside as market sentiment improves, making them an attractive option for investors seeking long-term value in a market that has yet to reflect its full growth potential. 

Views on Fixed Income

The U.S. 10-year Treasury yield has been on an upward trajectory, with the 10-year yield setting at its highest level since July [9]. This increase is driven by unexpectedly strong economic data, indicating that the Fed may implement rate cuts more gradually than previously anticipated by investors. The macroeconomic outlook for fixed income remains positive, with further rate reductions expected in 2024 and 2025. Given the robust economy, we anticipate strong credit fundamentals for investment-grade corporate bonds, with minimal deterioration in credit quality. We expect returns in the high-single-digit range over the next year, primarily due to elevated yields and low spread volatility. Any spread widening from growth concerns is likely to be offset by falling interest rates as focus shifts to potential cuts. The investors may consider allocating excess cash to quality fixed income as the rate-cutting cycle may continue and accordingly cash returns may erode.

Views on FX

The U.S. dollar has strengthened against major trading partners, reaching its highest point in over two months [10]. This surge is fuelled by stronger-than-anticipated economic data, rising Treasury yields, and recent polls suggesting a growing possibility of a second term for former President Donald Trump. The potential for a Trump administration return has further supported the dollar’s rally, as markets factor in the likelihood of extended tariffs, which could intensify inflationary pressures and sustain elevated U.S. interest rates. Reflecting this momentum, the DXY index, a broad gauge of the dollar’s value against major trading partners’ currencies, has gained approximately 3.8% in the past month.

Meanwhile, the Yen fell to a three-month low on October 28 following a significant electoral shift, as Prime Minister Shigeru Ishiba’s Liberal Democratic Party (LDP), which has governed Japan for nearly all its post-war era, lost its parliamentary majority in the national election on October 27 [11]. This outcome has heightened uncertainty about the composition of Japan’s next government and cast doubt over the economic direction of the world’s fourth-largest economy. Investors now anticipate that the LDP’s reduced influence may lead to a slower pace of interest rate hikes, which resulted in the weakening of the Yen.

Here is our perspective on the currencies market:

• Japanese Yen (“JPY”): In the medium, we maintain bearish on the USDJPY, given yield differentials supporting a level closer to 146, institutional discomfort with yen weakness in both the government and the Bank of Japan (“BOJ”), and markets pricing bullish US data.
• Euro (“EUR”): With price pressures easing in the Eurozone, September’s final inflation reading came in at 1.7% year-over-year, down from 2.2% in August and below the ECB’s third-quarter forecast of 2.3% [12]. This lower-than-expected inflation could prompt ECB policymakers to accelerate the pace of interest rate cuts to bolster the Eurozone’s slowing growth. In this context, we anticipate the Euro to trade on the weaker side as markets adjust to the prospect of increased monetary easing.
• Swiss Franc (“CHF”): The Swiss Franc (CHF) is expected to remain rangebound, balancing between competing factors. Elevated U.S. yields continue to draw capital away from CHF, as investors seek higher returns. However, the Franc’s safe-haven appeal, heightened by escalating Middle Eastern tensions, offsets this outflow. This tug-of-war between yield-driven outflows and safety-driven inflows is likely to keep the CHF within a stable range in the near term.

Source:

[1] ECB lowers rates and eyes more cuts as economy sags | Reuters
[2] ECB Cuts Interest Rates Again as Eurozone Inflation Slows – The New York Times
[3] U.S. Employers Add 254,000 Jobs in September as Economic Growth Remains Solid – The New York Times
[4] Blowout US employment report reinforces economy’s resilience | Reuters
[5] US Hiring Tops All Estimates, While Jobless Rate Falls to 4.1% – Bloomberg
[6] CME FedWatch – CME Group
[7] ‘Soft landing’ optimism spurs broad Wall Street rebound at big banks
[8] China flags more fiscal stimulus for economy, leaves out key details on size | Reuters
[9] 10-Year Treasury Yield Rises to 4.24%
[10] UBS Daily Asia – 24 October 2024
[11] Japan election: Country plunged into political uncertainty after voters deliver dramatic defeat to longtime ruling party | CNN
[12] Annual inflation down to 1.7% in the euro area – Eurostat