Opportunities and unrest in Q3
Amongst others, the third quarter is historically the weakest, on average, because of low economic activity due to the summer break in the Northern hemisphere. Another reason is the fact that analysts start to seriously gauge the following year’s prospects in the run-up to Q3 earnings, and this often causes some jitters, as this is perceived as a cut in earnings expectations.
However, on the bright side, this means there are buying opportunities ahead in the next four to six weeks. The fundamental reasons for that happening are that the upcoming data will confirm the soft-/no-landing scenario for the US.
US labour market cools, reducing inflationary pressure
The US labour market is cooling off, and inflation is behaving, which reduces the Fed’s urge to tighten the monetary reins. As a result, earnings expectations will keep stabilising and should improve soon.
Friday’s August US labour market report confirmed a cooling of the labour market with still solid job growth, in line with the soft-landing scenario for the economy. On the wage front, average hourly earnings slowed to 4.3% year-on-year, moving in the desired direction. Furthermore, the job openings data presented last Tuesday showed softening labour demand declined bringing the vacancy to unemployment ratio down to 1.5, which is further good news for policymakers.
All in all, the latest sets of US data appear to make life easier for the Fed, as further interest rate hikes look increasingly unnecessary. The course towards a soft landing confirms that the US is coping very well with the higher rates.
The consumer continues to benefit from a positive development of income, given that inflation has dropped below wage growth. Furthermore, cash reserves remain elevated, and indebtedness has decreased, both developments also reverberating effects from the pandemic support measures.
European Central Bank acknowledges weaker growth
Core eurozone inflation is going in the right direction but remains sticky, with the dispersion across countries relatively high. Last week’s inflation data in the eurozone offered first-hand indicators. The first estimates point to 5.3% y/y core inflation for the region in August, which is only marginally lower than the 5.5% y/y in the prior month. It is therefore going in the right direction but still remains sticky.
The dispersion among the countries is also worth noting. Headline inflation, which includes the more volatile elements, even came in above consensus; it is stuck at the 5.3% y/y figure already observed in July, as energy prices do not support the disinflation process so much anymore.
Apart from current inflation dynamics, the European Central Bank (ECB) also includes the inflation outlook and policy transmission in its assessment and decision-making. The published minutes of the July meeting reveal information about how the Council is taking these other pillars into consideration in their framework, acknowledging that the outlook has deteriorated in the eurozone.
A bittersweet cyclical environment ahead
Survey-based data continues to show a difficult cyclical environment ahead, yet the intended effect from interest rate hikes is clearly visible in a sharp slowdown in credit activity, which shows that the transmission is working well in the eurozone.
Hence, we believe that a rate hold at the September meeting next week is still likely and warranted, even if there is certainly the risk of an additional 25bps hike. From an investment perspective and considering the move in yields since the start of the second half of 2023, we see duration exposure in EUR becoming more attractive, closing the gap to the USD, where fiscal considerations further complicate the story.