By and large, things have gone well for multi-asset investors this year. The leading developed market equity indices are up by double digits, and fixed income performance figures are also broadly positive, as credit spreads have narrowed while overall yields remain attractive. Overall, market volatility has declined significantly and there is no stress embedded in current market pricing for developed market equities or bonds.

In the wake of resilient markets in 2023 (which are, indeed, much more resilient than anticipated at the start of the year), plenty of ink has been spilled on the ability of the US economy to deliver a ‘soft landing’ – i.e. a gradual slowdown in inflation without an abrupt collapse in economic activity. Is this a reasonable expectation, or have risk assets – and the bulk of financial market commentators – got ahead of themselves?

Locked-in rates bolster US economic resilience

Let us start by looking at US economic activity. In the second quarter of 2023, the US economy grew at an annualised rate of 2.4%, hence by more than expected and also exceeding the 2% rate of the first quarter of 2023. In the first quarter, it was remarkably strong consumer spending that surprised to the upside. In the second quarter, consumer spending slowed somewhat but increased business investment was able to fill the gap.

At the risk of being repetitive, the key to the remarkable resilience of the US economy is its reduced sensitivity to interest rate hikes. Both households and businesses have been able to lock in low interest rates for extended periods over the past decade. There is no immediate maturity wall approaching. As a result, consumer debt, mortgage servicing costs, and business financing costs will only gradually move up, meaning that both consumer spending and business investment are unlikely to weaken significantly in the near term.

Consumers’ asset income outweighs costs of debt

On private consumption, while excess savings have declined in recent months, there is still some fuel in the tank, especially among higher-income cohorts. Interestingly, as Empirical Research Partners points out, the US consumer is net long on short-term-yielding assets. In other words, the positive effect of higher interest income on the asset side of their balance sheets through owning money market and short-term fixed income funds more than offsets the negative effect of higher debt and mortgage servicing costs on the liability side.

Admittedly, taking all maturities into account, household debt servicing costs will increase slightly in 2023, as was already the case in 2022, but not to such an extent as to cause a meaningful drag on US consumption for this year. US economic activity, although slowing, is consistent with a ‘soft landing’ scenario.

Inflation heading south – albeit not in a straight line

Let us now turn to US inflation. In the first half of the year, price pressures in the US economy continued to ease gradually. US CPI inflation more than halved, from 6.5% year-on-year in December to 3.0% in June. Core US CPI inflation (excluding volatile food and energy items) follows a similar trajectory, albeit with a lag.

The release of the US CPI figure for July saw a slight increase to 3.2%, although it fell short of consensus estimates, partly due to the fact that the base effect was no longer as favourable as earlier this year. Indeed, as Ethan Wu of the Financial Times points out, the biggest increases in US inflation have occurred in the first half of 2022, so year-on-year comparisons for the second half of this year will not benefit from a comparatively high base. In short, disinflation may be less of a linear process going forward, but the market is past the peak of inflation fears and the direction remains south.

Tight labour market leading to wage growth

Finally, the last piece of the puzzle is the US labour market, which is subject to continued tightness. The Fed has repeatedly emphasised that a strong labour market and rising wages could further fuel inflation and must therefore be kept in check. Both structural and cyclical forces are at work.

The decision by some baby boomers to retire early has been a sizeable shock for the US labour supply, permanently reducing the size of the US worker pool. In the past, the baby boom cohort helped to keep wage growth anchored because its members did not change jobs as often as workers in other age cohorts. The early retirements among baby boomers and the associated decline in the cohort’s share of the total US labour force have allowed wage growth to pick up meaningfully.

As a result, the Fed has still not been able to bring the vacancy rate (job openings as a percentage of the US labour force) back to pre-crisis levels since it began its tightening campaign. However, the rate has recently started to fall as job openings have rolled over. Quit rates in the services sector, one of the areas where remaining tightness is concentrated, suggest that this trend is likely to be sustained – historically, a leading indicator that also precedes wage growth.

Policy actions likely to take effect and reduce risk of bear market

Overall, respectable growth, an intact disinflationary trend, and indications of a cooling labour market should put the Fed in a more comfortable position to enter a wait-and-see mode in the second half of 2023 as its policy actions feed through to the real economy. In the absence of major external shocks, we struggle to see a compelling bear case for the coming months. The ‘soft landing’ scenario remains our base case for the US.