In this week’s Perspectives, Fund Manager Anthony Rayner looks at the change in macro trends, and their impact on financial markets, and explains how this is feeding through to fund positioning.

The short term inflation picture in the US is seemingly under control and, with the corporate earnings season out of the way, attention is turning to the degree to which economic activity is slowing and, importantly, what this means for US rates.

Until recently, the market had been pricing in a soft landing but over recent weeks there have been sporadic bouts of concern that activity is slowing too fast, much of which has come from softer than expected US labour market data. The employment picture remains mixed and complicated by a number of distortions such as Hurricane Beryl in July, as well as a higher supply of labour, both new entrants and re-entrants.

However, there are some trends we can extract. Firstly, that US manufacturing job creation is weak and services is not, this is broadly consistent with what we’re seeing globally. Also, importantly, hiring is slowing (see chart below of non farm payroll, which includes a six month average line, as the series is famously volatile), even if there are few signs of companies actually shedding labour currently.

US hiring is experiencing a cooling trend

Source: Bloomberg 31.01.2021 – 31.08.2024.

Once the Fed rate cutting cycles commences, most likely on the 18th of September, we expect the focus on US economic activity to increase. Additionally, election noise will pick up and this will ensure the health of the jobs market remains centre stage.

The Fed will want to be, or at least appear to be, data dependent, and they have already stated that they want the labour market to stop weakening, and that the jobs market will be the primary driver of the direction and pace of cuts. A key risk the Fed will want to avoid is a vicious cycle, where job losses feed through to weaker consumer spending, which in turn feeds through to companies being forced to cut more workers, and so on. Avoiding this is not as easy as it might sound, as the labour market tends to be backward looking in nature, rather than acting as a leading indicator.

In addition, being data-driven might sound sensible. Indeed, it is a tacit admission that the models don’t work, which is refreshing (see recent Perspectives on modelling) but is especially sensible this time round. The latest cycle is always different on some levels but the last three drivers of US rate cutting cycles were when something went wrong: the TMT boom and bust, GFC and Covid, these are all in stark contrast to this time around. However, the downside of being data dependent is that it leads to much more volatility in markets, as we have seen over recent weeks, especially around employment data releases.

However, it’s by no means all doom and gloom at a US macro level. On other metrics, such as consumer and corporate balance sheets, the US looks pretty resilient. Meanwhile, if the data shows consistent activity weakening, or if there is another market rout, falling commodity prices provide the Fed with some air cover in terms of allowing deeper rate cuts.

So, from a portfolio construction point of view, we’re trying to balance the cyclical disinflationary pressures with our belief that in the medium term inflation will reaccelerate, and also balance that with the increased uncertainty in the activity outlook. This is where our pragmatic approach comes into its own, specifically, matching an assessment of the macro situation to what’s happening to price momentum at a sub-asset class level, for example US Treasuries and equity sectors.

For example, reflecting the disinflationary pressures and weaker economic activity, we’ve been reducing our mining and energy exposure, where price momentum has become more negative. We’ve also been introducing a number of traditional defensives where we see positive momentum, for example healthcare, telecoms and staples.

In bonds we have been adding to duration, again with disinflationary pressures adding to positive price momentum. Also, importantly, where inflation risk is not an issue, i.e. in the shorter term, we would expect developed government bonds to provide some diversification of equity risk, and this is something we have seen in recent routs.

Elsewhere, in terms of keeping an eye on the inflationary environment, we maintain our gold exposure and we have been adding to UK supermarkets which, again, have been experiencing positive momentum. As a result, our portfolios are more balanced currently but, as ever, we can move quickly if we get more clarity on either the activity or inflationary outlook.