Summary
The state of the US labour market will determine how fast the Fed cuts rates. We believe that the Fed has room to ease policy and potentially engineer a soft landing.
Market update
Equities: Global equity markets ended the month on a positive note, despite volatility stemming from a downturn in technology shares, a widespread cyber disruption, a shift towards smaller companies, and restrictions on tech sales to China. US equities returned 1.3%. Developed Markets rose 1.8%, while Emerging Markets underperformed with a 0.4% return, weighed down by declines in Taiwan (-4.1%), China (-1.2%), and South Korea (-0.5%). Asia Pacific ex-Japan markets returned 0.2%. The People’s Bank of China (PBOC) surprised markets by cutting the medium-term lending facility (MLF) rate from 2.5% to 2.3%. ASEAN markets rallied 4.1%.
Fixed Income: US Treasury yields fell across the curve in July. The two-year US Treasury yield decreased by 42 basis points, finishing at 4.29%, while the ten-year US Treasury yield fell 27 basis points, closing the month at 4.09%. Amid falling yields, global aggregate bonds (Bloomberg Barclays Global Aggregate Index) returned 2.8% while US Treasuries (Bloomberg Barclays US Treasury Index) gained 2.2%. The US high yield market (ICE BofA US High Yield Index) returned 2.0%. The Asian credit market (J.P. Morgan Asia Credit Index) returned 1.3% as both high yield and investment grade bonds posted gains.
Macro overview
Growth: The J.P. Morgan Global PMI Composite Output Index has remained above 50 for nine consecutive months, indicating still positive global economic expansion. However, recent data shows signs of easing, with the manufacturing new orders component falling below 50 for the first time in recent months. Economic surprise index (ESI) data are also deteriorating, with broader economic data coming in below consensus expectations across key regions. Despite US retail sales exceeding expectations in July, in our view, a weaker US labour market could limit wage growth and consumer spending, and slow US demand, which has been a key driver of global growth thus far
Inflation: Inflation pressures showed some signs of easing in July as the US Consumer Price Index (CPI) rose by 0.2% month-over-month, and by 2.9% year-over-year, the smallest annual increase since March 2021. Core CPI increased by 3.2% year-over-year, the smallest annualised rise since April 2021. We continue to track labour market conditions and wage trajectories for inflation risks. While supply-side inflation risks could arise due to geopolitical tensions (i.e., a deepening of the Middle East conflict), for example, we expect inflation to moderate as a weakening US labour market reduces overall demand.
Monetary Policy: Given softer inflation data and weaker-than-expected US employment data in July, the Federal Reserve (Fed) is likely to start cutting interest rates. The pace of rate cuts will likely depend on how quickly the US labour market deteriorates. If the Fed acts too late, a deeper slowdown may emerge, despite healthy consumer and corporate balance sheets. Nevertheless, we believe that the Fed has room to ease policy and potentially engineer a soft landing.
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