Weekly letter - 21 August 2023
Several hypotheses have been put forwards to explain the bond market stress seen in recent weeks in the United States as disinflation continues. The starting point is a highly inverted American yield curve, in addition to which:
- the positive economic surprise index has led to dwindling expectations of recession
- the budget deficit remains “too” high (7% of GDP while the unemployment rate is at a historical low)
- technical factors are encouraging an uptake in bond issues (anticipation of a supply glut)
- higher inflation is feared with real household incomes rising in the second half of the year.
The fact remains that this trend, which can be described as normalisation in the economic context, has brought US rates to levels comparable to those of the early 2000s, i.e. well above those seen during the years of “secular stagnation” after the 2008 financial crisis.
But is that enough? Although these levels appear to be more coherent/consistent with the prospects for the nature of the landing of economic activity that is currently emerging in developed countries, consolidation could still continue as the US yield curve remains inverted by more than 1%. As always, observers will pay close attention to the comments of leading central bankers at the Jackson Hole meeting this week (24–26 August). The Fed’s minutes from July showed a near consensus for the latest rate increase of 0.25% and bringing US rates to 5.25%–5.5%. The majority of members indicated that inflationary pressure was still growing and that demand was expected to slow further to bring inflation back to its 2% target over time. The speech by J. Powell, the Fed’s chair, is therefore expected to be in this vein, or even a little stricter, in view of the resilience shown by the latest economic statistics.
This context is temporarily weakening the equity market and investor sentiment, where the outlook has improved compared to pessimistic expectations at the beginning of the year. Operators have significantly increased their exposures over the last three months, particularly to cyclical securities in response to improvements in their economic prospects. Bond market stress could resurrect fears of an economic slowdown or even a financial shock if they continue, leading to increased market consolidation.
We have chosen to steer clear of fixed-rate investments over the last few months because of their high costs. The substantial correction over recent weeks could lead us to reconsider this position.
While remaining vigilant regarding the evolution of financial conditions, we maintain a constructive scenario with respect to economic activity. Future growth is supported by significant factors such as renewed household purchasing power, with the rise in real incomes in the second half of the year, and the approaching trough from the clearance shock in the manufacturing industry. Our equity exposures therefore remain stable.