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Lap of luxury

The ‘recession vs soft landing’ debate seemed very much in the hands of the doomsayers this summer. The latest US employment report has somewhat levelled the playing field – the job market is alive and kicking and only showing tentative signs of a slowdown. Discover the views of our experts in this Research Weekly.

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Yes, there are major issues around the world – war, energy supply, Covid-19-related lockdowns, and what have you. Yet the economic recovery does have legs, as there is still a major catch-up to be done after two years of restrictions in life.

This is especially the case in developed economies with more than two thirds of their economic output being in consumption. Hence those expecting an immediate drop in economic activity may want to be careful, especially about the timing. The US labour market was as vibrant in 2006 as it is right now. At the time, it had already two years and 400 basis points of rate tightening behind it. And it still took another two years to bring the economy down.

Put into today’s perspective, this means that the economy can keep ploughing ahead for quite some time until gravity takes over. Not to speak of any relief in terms of some of the sentiment issues mentioned above that could ease some of the pain points substantially.

But agreed, we have entered a new stage of the cycle, as long-dated bond yields have likely peaked for the year. While valuations are no real hurdle for the space, we think that going forward the limited upside in bond yields is. Conservative investors relocate funds into defensive growth stocks such as healthcare names. And contrarians may want to dip a toe into a more controversial space: luxury goods. Margins are a statement here (see ‘number of the week’), and one of the few areas where European corporates still rule.

Number of the week

What do our experts think about the latest reports?

The June US labour market report surprised positively. This prevailing resilience of the US labour market supports our view that a US recession in the coming 12 months is far from being a forgone conclusion. Non-farm payrolls increased in June by 372,000, which is more than expected, and the unemployment rate remained at its record low of 3.6%. At the same time, the pace of job creation is slowing, and the labour market’s overheating is receding. Job openings and resignations have peaked, jobless claims have bottomed, and the ISM employment indices have fallen below 50, signalling a contraction in the month ahead.

The current data suggests that the US labour market is rebalancing in line with softer economic growth.

Further, the alternative household employment survey indicates no employment growth in the past three months. The gradual rebalancing of the labour market helps to bring down the growth rate of average hourly earnings and increases our conviction that the current US growth slowdown will not be sped up by rising unemployment, which inevitably would lead into a recession. The current data suggests rather that the US labour market is rebalancing in line with softer economic growth.

The so far resilient labour market allows the US Federal Reserve (Fed) to focus fully on the elevated level of inflation and continue its determined action to bring its policy rate to a neutral level. We assume that a policy rate of 2.5%–3% is neither stimulating nor constraining economic activity in the US. We expect the Fed to lift its policy rate by 75 basis points at its next meeting on 27 July, entering the neutral policy stance. The upcoming June inflation report is expected to show another headline inflation increase due to higher energy prices and serving as the main justification to hike rates more aggressively than usually.

Beyond the July Federal Open Market Committee meeting, we expect a slowing economy and receding inflation pressure to slow the pace of rate hikes by the Fed, thereby helping to engineer a soft landing of the US economy over the coming months.

How should you position your portfolio in the view of Julius Baer's experts?

> Contact us to find out