US Fed refuses to give guidance at Jackson Hole summit

US Federal Reserve (Fed) Chair Jerome ‘Jay’ Powell declared that the Fed is firmly resolved not to commit at this point to a decision on whether it wants to raise its policy rate further or whether interest rates are already at a sufficiently restrictive level. Powell appeared quite hawkish, and the likelihood that the Fed will raise rates at the November meeting has increased. At the same time, he emphasised that the Fed would act carefully in its next interest rate decisions.

The probability of a rate hike at the next Federal Open Market Committee meeting in September, which is priced into the money markets, remained below 25% after this remark. We anticipate that the Fed will decide that further monetary tightening is unnecessary based on incoming data, including weaker economic activity and a cooling labour market. At the same time, we see a high hurdle for rate cuts in early 2024 and expect a first rate cut in May at the earliest.

Higher US interest rates keep the dollar resilient

Since mid-July, the US dollar strengthened considerably from our previous 3-month forecast levels of EUR/USD 1.12 to currently 1.08. The main driver behind this development has been better US economic data, which showed that the robust US economy is fending off a recession that had triggered a rise of US interest rates.

Although we believe that the US Federal Reserve has reached the peak of its tightening cycle, the better cyclical environment is likely to keep US interest rates higher for longer. At the same time, the cyclical weakness in the eurozone, partly due to the Chinese economic slowdown resulting in less demand for European exports, has caused European rates rather to decline.

Therefore, the currency drivers that looked more balanced since the summer 2023 have shifted more in favour of the dollar. Taking this into account, we revised down our EUR/USD 3-month forecast from 1.12 to 1.10. In the longer term, we still expect some softening of the dollar to our 12-month forecast of EUR/USD 1.12.

Emerging market hard-currency and Asian investment-grade bonds downgraded to Neutral

The Overweight rating for the emerging market hard-currency complex introduced late last year was based on the China reopening theme, USD weakness, and a relatively high oil price. However, throughout this year, these arguments are not delivering the same supportive backdrop anymore. With the resulting spread tightening, we view current valuations as fair and have thus downgraded the segment from Overweight to Neutral. Nevertheless, even after this downgrade, we see more value in this segment compared to global high-yield markets, which we continue to underweight, since they do not account for the default outlook.

Staying with bonds, we also recently downgraded Asian IG bonds to Neutral given that Asian IG credit spreads, at ~150bps, are priced to perfection. We like the high-quality, low-beta credits in the China segment but are wary of the downside risk from an insufficient policy response to combat a slowing economy. Thus, our Neutral view is about risk management given a potential rise in risks and volatility and is also underpinned by the yield buffer from the US Treasury and relatively high total returns. We continue to avoid Asian high yield due to a grim China property outlook and refinancing challenges.

China’s impact on equities limited – buy the dips

Turning to equities, after a stellar performance during the first seven months of 2023, developed-market equities have started to correct in August. One of the reasons for the latest correction is increasing concerns about a potential balance sheet recession in China and its impact on the global economy and financial markets.

We still see limited contagion risks through the financial market channel given the closed capital accounts in China. Moreover, the direct revenue exposure to China of the world’s largest equity capital markets (the US) is less than 5%, which is manageable. For now, we would avoid companies in the US and Europe with high revenue exposure to China. We recommend waiting for more decisive policy action by the Chinese government to restore market and consumer confidence before hopping back on the trade.

The domestic economic backdrop in the US is of a much higher importance than the China situation for US equities, which continue to be on a solid footing. The latest developments reinforce our preference for US equities over European ones, as they are fundamentally less exposed to the Chinese consumer. September historically coincides with the most unfavourable month for equity returns. Hence, we expect volatility swings to characterise the next few weeks, although we suggest that investors look at opportunistic buying into the dips, since we believe the secular bull market is still intact.

Gold and silver left unmoved by US Fed statement

Gold and silver markets hardly reacted to the Jackson Hole speech of US Federal Reserve Chairman Jerome Powell. Prices remained rangebound, at around USD 1,915 per ounce for gold and USD 24.2 per ounce for silver. Our views are unchanged: the outlook for US growth, inflation, and monetary policy is the single most important factor driving gold and silver prices at the moment. Recession risks have clearly receded, and expectations of a rapid reversal of monetary policy have disappeared.

Barring a deterioration in the economic outlook, which would lead to a rapid reversal in monetary policy, we expect a further fading of safe-haven demand. We thus stick to our Cautious view on gold, implying more downside than upside. We also stick to our Neutral view on silver, even though it is looking a little expensive following the mid-month rally, which we struggle to explain with fundamental factors.