The ISM purchasing managers index has shown mixed signals, with the manufacturing component coming in lower than expected for the fifth time in six months but the services equivalent came in above consensus forecast.
The signs of a slowing economy have led to more calls for a US recession, but the world’s largest economy has continually defied calls of this nature over the last 18-24 months as it has outperformed expectations. The rapid tightening of monetary policy led several observers to predict a US recession last year, but this failed to transpire. Central bank policy has been in restrictive territory for 12-18 months now, so it should not be too surprising that activity has slowed in the face of this headwind. That said, the last 12 months have been a good time for stock market investors, with double-digit returns from US indices.
We believe it is important not to lose sight of the big picture and as long as layoffs remain relatively low, the US economy is unlikely to experience a hard landing. Our view continues to be that we are heading for a soft landing, but we are monitoring upcoming data points closely, looking for signs to support or adjust this stance. It is imperative to not overreact to near term volatility and one-off data points but to look through the noise and focus on the underlying strength and adaptability of the current economic landscape.
Central banks diverge
Three central bank decisions around the globe in less than 24 hours at the turn of the month attracted plenty of attention as the Bank of Japan (BoJ) raised rates, Federal Reserve (Fed) maintained existing policy and the Bank of England (BoE) delivered its first rate cut since 2020.
First up, the BoJ delivered an unanticipated interest rate hike to take its base rate to 0.25% from the 0%-0.1% range while also reducing its bond buying programme. The policy tightening appears to be the clearest signal yet that the BoJ believes inflation is finally returning in a sustainable manner. While much of the developed world has struggled with high inflation in recent years, raising rates substantially in an attempt to rein it in, Japan has been one of the few countries that perhaps welcomed the surge in global price pressures given its prolonged battle against predominantly below target (2%) inflation since the mid-1990s. The interest rate divergence has led to a large depreciation in the Japanese Yen in recent years but after hitting a 34-year low earlier in 2024, July saw a marked appreciation with the Yen gaining almost 7% against the US dollar.
Just over 12 hours after the BoJ news the Fed announced it would maintain its interest rate at 5.25%-5.50%, making it eight consecutive policy meetings that have decided to keep it at a 23-year high. However, there was the strongest sign yet that a cut will follow at the September meeting, as the accompanying statement declared the committee was “attentive to the risks to both sides of its dual mandate” — suggesting there has been a shift towards greater concerns regarding the unemployment rate and away from as greater focus on curbing inflation. Stocks and bonds welcomed the news with strong initial reactions to the upside.
The following day the BoE cut rates for the first time since the Covid-19 pandemic, lowering its base rate to 5%. The rate had been at 5.25% since August 2023, but a close split among rate-setters (5-4) suggests it was a close-run thing and given market expectations for a reduction going into it, it could be described as a hawkish cut. Furthermore, the lack of a strong consensus suggests that the move lower does not necessarily signal the start of a sustained cutting cycle. The bank’s economic projections also add credence to this view, with inflation forecast to rise to 2.7% this year before slowing.
Gilts ended July with a positive return, supported by growing expectations of the aforementioned cut and a global shift to lower yields. A broad-based gilt index returned 1.99% on the month to recoup a fair portion of the 2024 declines. Overall, we feel the long-term backdrop is positive for bonds with inflation moderating and interest rates likely to have peaked. Having said that, we have some concerns in the coming months regarding the US election and the potential impact of a Trump presidency on longer-dated bonds, given that he favours tax cuts despite the wide US fiscal deficit. Tariffs and tighter immigration policies may also prove inflationary if they are enacted. Of course, this is likely to matter more for the US economy than the UK but government bond markets are closely correlated, as we know.
Conclusion
The market moves in recent days included sizable declines in markets that had hitherto performed well year to date. Many of these are cyclical in nature and sensitive to economic growth, such as tech, Japan and commodities. Corrections of this nature are not a rare occurrence and history tells us that they are often an overreaction. The ISM non-manufacturing print beat expectations and we believe that further indicators in the coming weeks will reassure markets that growth is not falling off a cliff, rather that we are slowly moving to a soft landing scenario. As always, we remain objective and ready to change this viewpoint if the trends in data strongly suggest otherwise, but until then we maintain this stance.
We are now more than two thirds of the way through earnings season and, generally speaking, companies in all regions are beating expectations in aggregate. Tech and financials are performing particularly well, even though the former has seen some market weakness due to sky high expectations. We take reassurance from the fact that businesses continue to post profits ahead of consensus forecasts, and that all major equity regions are predicted to provide year on year earnings growth in 2024 and beyond. Fixed interest continues to offer attractive yields and we expect it to dampen declines for multi-asset portfolios if we experience more stock market volatility, as we saw with bonds rallying during the recent correction.
