The strength of global and especially US economic growth over the last two years has surprised us and many other market participants. The post-COVID cycle has been extremely hard to read, with data giving diverging signals, and bouts of geopolitical volatility and financial stability concerns (US regional banks and Credit Suisse) adding noise to the mix.

Moving forward, we see late cycle dynamics and signals that restrictive monetary policy is having an impact although with somewhat of a lag.

In major developed markets (DM), many countries are showing a steady increase in the unemployment rate. Although current values might seem small relative to history, these time series rarely give false signals. For example, the US unemployment rate has gone from a low of 3.4% to the current 4.0%. This increase is not trivial.

US: Two job markets and consumer fatigue

The US has exhibited strong economic growth in the past two years. We think a slowdown might be warranted at this stage and see signs of weakness in the two pillars of the post-COVID cycle: the job market and consumer demand.

We see a tale of two job markets, with positive data from the establishment survey showing continuous growth in nonfarm payrolls, while data from the household survey (which is used for the unemployment rate) showing negative growth in new employees since the beginning of the year and a much lower pace of job creation since 2021.

These two surveys have some key compositional differences, but it is likely that the true state of the US job market might be somewhat weaker than what payrolls numbers indicate. Strong growth in part-time jobs and contraction in full-time jobs is another discrepancy worth monitoring. The US job market today looks much less tight than two years ago. This should support further normalization in wage growth as well. In fact, with productivity running at somewhere between 1.5% and 2%, we would argue current rates of wage growth are conducive to the Fed’s 2% target.

A second key theme remains US consumer fatigue. Consumers and their relentless spending have been the engine of the post-COVID recovery, and in the past year we have been flagging the decrease in excess savings accumulated during the pandemic and the deterioration of consumer financial health. The increase in delinquency rates for consumer loans is a clear symptom of fatigue, and recent core retail sales have been pretty much flat in nominal terms. Also, large retailers have been much less optimistic on recent earnings conference calls, and this is reflected in recent weakness across retail sales data.

Monitoring UK weakness

Outside the US, we see no signs of resurgence. The recovery in manufacturing PMIs has stalled, and recent volatility from European elections adds some political uncertainty to an already weak mix of higher energy prices, low competitiveness vs. cheap goods from China and lack of additional space for fiscal spending.

The United Kingdom is worth closely monitoring. Rates on the current stock of mortgages saw a sharp increase from 2.0% to 3.6% currently, a much faster increase than the US (3.2% to less than 3.8%). As effective mortgage rates continue to increase, the buffer for consumption will continue to fall. Job creation has also been much weaker in the UK.

Disinflation story is intact

After an inflation uptick in Q1, we found that the disinflation trend is still alive in Q2 US numbers (especially May and June). Strong seasonality in month over month (MoM) inflation and unreliable seasonal adjustments have made the assessment of the true progress towards a 2% target quite complex. If we revert however to more basic metrics and just look at Not Seasonally Adjusted MoM numbers for the US Core Consumer Price Index, it is interesting that since October 2022 monthly inflation has come below the same figure reported a year earlier in 19 out of 21 months.

This is not surprising as most of the usual drivers of inflation have been absent. In the last two years: 1) Money supply growth has been non-existent across major DMs; 2) Commodity prices (Bloomberg Commodity Spot Index) are down -15% through June; 3) Food prices (UN FAO Food Price Index) are down -23%, also through June; 4) Supply chain pressures have eased.

Prospects of job market slack also remove a potential wage-price spiral. What remains is the last echoes of inflation of the past, coming from items like shelter or auto insurance, which are likely to drift lower (the drop in shelter in the June CPI report was especially noticeable).

Investment implications

In such an environment we think that in the coming years there might be space for DM central banks to cut rates up to a larger extent than what is currently priced by the market.

We see material value in DM government bonds (especially the US and Australia) and some emerging markets (Brazil, India) and prefer to keep historically high duration exposure across our portfolios. With a few exceptions, the bar for material rate hikes from here looks extremely high. We see meaningful value along the curve and think it makes sense to keep a diversified stance in terms of maturities.

In our view, corporate credit markets look mispriced, with global investment grade and high yield spreads well below long-term averages and of course well below recessionary averages. Lower exposure and selectivity remain key themes for us.

The beginning of 2024 has brought strong refinancing activity and many companies have worked their way through the “maturity wall.’’ Not all the increase in rates has been absorbed and the cost of debt might still see some uptick for some companies (especially in the B/CCC space). The increase in idiosyncratic volatility and the substantial “amend and extend” activity in the background also may be signals of stress.

Yield cushion

Notwithstanding the above, we believe the overall level of yield provides a decent cushion which will support total returns even in an environment of higher spread volatility, especially within investment grade, where strong investor demand to lock-in yields has been a key supporting factor. More recently, high yield markets started to see an increase in investor demand as well. We see some dispersion across regions, rating segments and sectors. In particular, the lower quality segment of the European HY market continues to be out of sync with the rest of the market.

We continue to see value in more defensive sectors such as telecommunications, healthcare, consumer staples and selectively across financials We see weakness ahead in more cyclical sectors (e.g. chemicals) and areas more exposed to consumer behaviour (e.g. automotive, retail).

Emerging markets can offer some interesting opportunities in corporates, but mostly single names in major countries.

We think it makes sense to remain prudent in FX, keeping exposure only in those areas where there is clear justification in terms of outstanding real yield (Brazil) or a strong economy and supportive technicals (India), and to remain constructive on the US dollar.

The value of active minds – independent thinking

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

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