Navigating Shifting Economic Prognosis and Global Implications

In the world of global markets, the tides of economic performance are showing signs of change, sparking shifts in the outlook for yields and the ripple effects on risk assets.

Robust Economic Performance in the US

The economic landscape in the United States remains a focal point, with recent indicators painting a picture of resilience and strength. The nowGDP index produced by the Atlanta Fed, growing at an annualized rate of 5.8%, has demonstrated a remarkable recovery, signifying a robust foundation for further growth. Concurrently, the US retail sales figures exceeded expectations, indicating a consumer-driven economy that continues to defy projections.

Notably, unemployment claims remain at historically low levels, contributing to a sense of full employment and overall economic stability. Capacity Utilisation– a key measure of CapEx activity – has rebounded to 79.2%, erasing the declines witnessed during the pandemic. This reversion not only reinstates pre-COVID levels seen from 2016 till 2019 but also highlights a rebound in business investments, underscoring confidence in the economic trajectory.

Federal Reserve's Balancing Act

As the US economy shows strength, the focus shifts to the Federal Reserve's future actions. The upcoming Jackson Hole Symposium holds the attention of market participants, who are eager to glean insights into the central bank's stance. Although Chair Powell's speech remains an enigma, the market has interpreted recent data as indicative of an economy still performing well.

The trajectory of inflation remains a point of interest, with a possible plateau around the 4% mark for core inflation. This raises questions about the duration of elevated inflation levels and their implications for interest rates and monetary policy.

Repricing in the Yield Curve

One of the most notable developments has been the repricing of rate expectations across the yield curve. The market has recalibrated its outlook, with a marked uptick of around 50 basis points in the 2024 Fed funds curve. This shift, from anticipating rate hikes followed by pauses and cuts, to a stance of hikes, pauses, and no cuts, has caused a ripple effect through the bond market.

This repricing encompasses not only the Fed funds curve but also inflation expectations and credit considerations, triggering a step function change in the entire treasury curve.

Equity Markets and Global Variances

The repercussions of the yield curve repricing have left their imprint on equity markets. While there have been modest fluctuations, the question arises: has the market witnessed the peak in equity values?

Some indices have experienced a minor retreat, suggesting a possible period of consolidation. Russell is doing okay. Dow is definitely doing okay. Tech (NVIDIA and Microsoft, for example) has come back a bit. Overall, the S&P went from almost 4600 to 4400 now. But it’s still solid.

In Europe, economic indicators are mixed, with inflation persisting at 5.5% but GDP growth lagging. European equities continue to track US markets, underscoring their interconnectedness.

Global Dynamics and Currency Response

Global dynamics have added complexity to the market landscape. Disparate data from Asia, exemplified by China's deflationary territory and Japan's robust GDP growth, hint at nuanced trends. The question of whether China could export deflation remains uncertain due to altered export dynamics.

Surprisingly, the response of the US dollar to rising yields has defied conventional expectations. Against the Euro – which is the main contributor to the DXY (Dollar Index)– it's hovering around a flat line. Even cable hasn't really moved despite UK CPI being lower than expected last week, at 6.8%. The dollar's correlation with risk assets has left it more influenced by their performance than by yields, highlighting an intriguing anomaly.

Commodities and Outlook

The commodities space presents a mixed picture. Certain soft commodities such as wheat have not reacted significantly to geopolitical tensions. The energy market, particularly oil, is displaying a tangible impact on the US economy, with rising oil prices transmitting to consumer inflation.

Oil has rebounded to USD 82 per Barrell, after having reached a low of 69-70 two months ago. SPR’s recent depletion offers limited scope for mitigating these effects, raising questions about the potential trajectory of headline inflation.

Looking Ahead

As the market navigates these intricate dynamics, risk assets continue to exhibit resilience. Equities, fixed income, and other key asset classes appear to have settled into a pattern, with incremental movements reflecting the evolving economic landscape. Equities may move within a 3% margin up or down. Fixed income is likely to stay within five basis points up or down.

While upcoming events such as the Jackson Hole Symposium and increased market participation in September might inject new energy, the overall sentiment appears cautiously optimistic.

In conclusion, the evolving economic landscape has prompted shifts in market perceptions, particularly with regards to yields and risk assets.