Monthly update: US economy doubts cause market volatility but fundamentals hold firm

Sahm-thing important to note

Lilian said a big example of this was that the Sahm rule was triggered for a very different reason than in the past.

It has an excellent record of signalling recession historically because it has been triggered by layoffs which then caused people to spend less. But that’s not the case this time around.

Lilian explained: “This time the unemployment rate has risen because there are more people wanting to work because of new entrants to the market and immigration. So, while there is no doubt economic momentum is slowing and the labour market is loosening, this instance of the Sahm rule being triggered is less sinister than previous ones.”

He added: “Here at Coutts, we believe we are seeing a slowdown after very strong growth over the past 12 months. The economy is weakening in the US, but that doesn’t mean it’s weak. And as such, conditions remain positive for risk assets generally.”

The volatility is not just about what’s happening in the US. There is something else at play in markets that is also contributing. Over in Asia, the strength of the Japanese yen over the past few weeks led to a popular currency ‘carry trade’ unravelling – typically, a low-yielding currency funds such a trade in a higher-yielding currency, benefitting from the difference between rates.

This has led to a number of margin calls and sell-offs, but it is more of a technical development rather than something fundamental to the overall economy.

Interest rate cuts now more likely

More importantly, a looser US labour market and cooling US economy make it unlikely inflation will pick up again, and mean the chance of a US interest rate cut in September is now much higher. Also, continued volatility could see the US Federal Reserve (Fed) cut rates by 0.5% instead of the previously expected 0.25%.

At the central bank’s last meeting in July, policymakers held off lowering rates but left the door open to a September reduction. As well as inflation falling, the Fed’s preferred measure of rising prices – the Personal Consumption Expenditures (PCE) Price Index – has also edged lower.  

The Bank of England, meanwhile, cut interest rates for the first time in four years last month, from 5.25% to 5%. The drop in borrowing costs is good news for homeowners and comes after inflation held at the central bank’s 2% target for a second consecutive month in June.

WHAT DOES THIS MEAN FOR YOUR INVESTMENTS?

Our analysis had already shown the US jobs market starting to weaken, but we still saw solid long-term economic fundamentals. This means we continue to favour stocks, recently shifting our equity holdings to a more global positioning.

Meanwhile, the taming of inflation and strong chances of interest rate cuts saw us increase our exposure to US government bonds, given attractive valuations.

Other recent changes to our client funds and portfolios include taking profits and closing our holdings in gold and high yield bonds.

One of the reasons for holding gold was its diversification benefits if inflation went above market expectations. That risk has now reduced and, given that gold performed much better than expected, we decided to sell our remaining allocation.

As for high yield bonds, an important tenet of our ‘Anchor & Cycle’ process is to take risk where it’s best rewarded, and a strong performance from these bonds caused their yields to move closer to their less risky counterparts.

If you are a Coutts client and would like to discuss any of this in more detail, please contact your private banker.