Insights

President Trump’s inaugural speech outlined his second term agenda. The theme was that the US will become “far more exceptional” than it already is. Trump pledged to reverse America’s decline, rebalance the justice system, streamline government, protect borders, pare back inflation, restore manufacturing, surge energy production, impose tariffs on trade, and make peace abroad. Trump declared two national emergencies: One on the southern border, and one on energy production.  

Trump said the US will impose tariffs to protect US manufacturing. This would include creating an External Revenue Service to collect tariffs, implying a vested interest in tariff collections. On foreign policy, the military will focus on its main objective of war, but success would be measured by ending wars and staying out of wars, implying negotiations on Ukraine and in the Middle East.  

However, he reserved his fighting words for Panama, lamenting the alleged abuse of the US treaty ceding the Panama Canal. He said the US was “taking it back,” opening the potential for military action even though the more likely consequence is simply a renegotiation of relationships in an area where US influence is already overwhelming.  

For investors, the takeaway is that the Trump administration will be proactive, not reactive; unilateral, not multilateral; and hawkish, not dovish, on global trade and immigration. Equities remain expensive given the risks ahead.  

The Federal Reserve’s Beige Book shows a modestly growing economy imbued with post-election optimism, while highlighting some caution about employment.

The latest Beige Book is in line with other sentiment indicators showing modest growth but increased post-election expectations. The picture remains the same for employment, with a slowing-but-not-collapsing labor market. Consumer spending also exhibited some minor cracks, with higher price sensitivity and reduced spending on big items.

Our Beige Book Monitor confirms this narrative. Our sentiment indicator is in positive territory for the first time since April. The growth re-acceleration is, however, already reflected in asset prices. Despite Chairman Powell signaling more patience for rate cuts given recent data strength, our base case continues to call for a recession next year. We expect further slowdown in the labor market to stifle US consumer spending, and global growth to suffer due to trade tensions. Accordingly, our US Bond strategists recommend maintaining above-benchmark portfolio duration and steepener positions on a 6-to-12 months basis. They are also tactically long the December 2025 federal funds futures contract.

The US dollar steamrolled its peers since early October. After breaking out above its 200-day moving average, it is now fast approaching recent highs. Multiple factors drove this rally, among them are the stronger-than-expected US economic data, weaker data overseas, and Trump’s victory.

In the very near-term, we see further dollar strength. The dollar is a momentum currency, and positioning is neutral while sentiment is not extended either. Furthermore, deregulation initiatives, tariffs weakening overseas growth, and loose fiscal policy will boost dollar sentiment. This policy mix will remain the market’s assumption until more clarity emerges on the policy agenda and its sequencing.

In the long-run, the US dollar is expensive, as are US assets. The current rally is thus likely to be the last leg of a structural bull market in place since 2011. It will end as the Trump administration aims to weaken the currency to rebalance trade.

The October global manufacturing PMI printed at 49.4, up from 48.7 in September but still in contractionary territory. While output stabilized at 50.1, new orders (48.8) and new export orders (48.3) remain in contraction, as is the case for the new orders-to-inventories spread.

This rebound is in line with recent soft data showing that the global manufacturing cycle is still contracting, but at a lesser speed. While positive at the margin, this still paints a worrying picture given risk assets are richly valued.

Macro momentum points to much lower future returns for equities vs. bonds, after their massive outperformance led by US equities. The US election brings considerable uncertainty for the rest of the world, as a Trump victory would translate into trade tariffs and a headwind for global growth.

Job openings missed expectations at 7.44 million in September, a mild slowdown from August. The details of the JOLTS report were also negative, except for hirings which continue their June rebound. Meanwhile, consumer confidence for October data beat expectations. The Conference Board’s labor differential – a proxy for the difficulty of finding a job – signaled a marginally tighter labor market from September.

The labor market continues to cool. The gap between quits and layoffs, which leads labor demand, ticked down and now sits below pre-COVID levels. Layoffs are rising, albeit from a low level.

The JOLTS confirm that the US economy is slowing and could soon approach a tipping point. Meanwhile, equities remain priced for a perfect soft landing. Considering this dichotomy, investors should be positioned more defensively going into next year, with tactical flexibility going into the US election next week.

Preliminary estimates suggest that activity continued to slow across DM economies in September.

Manufacturing PMIs contracted at a faster pace in the US, Eurozone, Germany, France and Australia, and grew at a slower pace in the UK. Services PMIs continued to expand in most regions, though the pace of growth slowed. Notably, the Olympic Games’ one-off boost to France’s services PMI in August completely wore off in September, with the country’s services PMI unexpectedly shedding a whopping 6.7 points to 48.3.

A holiday is delaying the release of Japan’s preliminary PMIs for September. In August, the country’s manufacturing PMI extended a second month of decline (after a couple of brief stabilization episodes broke a nearly two-year contraction streak).

Details of the US flash PMIs highlight a sharp worsening in domestic and foreign demand conditions in the pro-cyclical manufacturing sector, as well as a deterioration in the employment components of both sectors.

The US has been a large source of global demand this cycle and a US recession morphing into a global downturn remains our base case. Last week’s outsized rate cuts will work with a lag and are thus unlikely to alter the course of the ongoing labor market softening over the next 6-to-12 months. Meanwhile, Chinese demand is unlikely to fill the void given the stimulus is timid in scope and inadequate in nature.  

Cyclical investors should underweight equities and overweight bonds, avoiding pro-cyclical Eurozone and EM equities in favor of US equities. 

According to BCA Research’s Counterpoint Strategy service, the post-pandemic US economy has inverted from its usual ‘demand-constrained’ state to a highly unusual ‘supply-constrained’ state. This inversion is still a ways from normalizing, with labor demand still exceeding supply by 2.2 million jobs, or 1.3 percent. 

In the supply-constrained state, it is the evolution of supply, not demand, that drives output. Even as labour demand has gone into recession, the growth in labour supply has driven GDP. In a supply-constrained economy, output will go into recession only if supply goes into recession. Or if the economy ‘un-inverts’ back to demand-constrained and demand stays in recession.

If the current recession in labor demand is mild, as in 1990 or 2001, it is almost halfway complete. By the time the economy un-inverts back to demand-constrained, most of the recession in labor demand will be over, leading to a fascinating possibility:

The highly unusual inversion of the US economy means that despite suffering a typical labor demand recession, the US could cheat a GDP recession.

Many contend that the inversion of the US economy is overstated because the jobs and job openings that make up labor demand are overstated. However, our colleagues argue that the jobs data is based on the generally reliable Household Survey rather than the heavily (and recently) revised Establishment Survey. Meanwhile, the JOLTS job openings data are buttressed by their excellent explanatory power for wage inflation, which suggests that they are currently more likely to be understating demand.

One other possibility is that the supply-constrained US economy goes into recession because labor supply goes into recession. It could happen if labor participation fell sharply and/or net immigration turned into net emigration. This would be a major risk in a Trump administration, though that outcome is not a central case.

Market and economic observers have devoted a lot of attention to the Sahm Rule following July’s employment report, and whether or not it has been triggered. BCA’s analysis has highlighted that the overall direction of the labor market is far more important than the rounding conventions one applies to determine if the unemployment rate has risen enough to meet the exact trigger threshold.

Moreover, investors should keep in mind that the unemployment rate is a lagging variable. Employers typically resort to firing as a last resort. It is therefore worth remembering that the Sahm Rule is not a leading indicator of the economy. Our Global Investment strategists showed that on average, the Sahm Rule has lagged the onset of past recessions by a couple of months.

History therefore suggests that a recession could already be underway even if the Sahm Rule hasn’t been triggered.

Importantly, the hiring rate from the JOLTS report is a more forward-looking indicator. Firms typically stop hiring before they resort to layoffs. Our US Bond strategists also view it as the “purest” indicator of labor demand, since it is not affected by changes in labor supply. The hiring rate has been directionally consistent with a deteriorating labor market for a while.

Households’ perception of labor availability also influences their behaviors and consumption patterns. The quits rate (also from the JOLTS report) and the share of consumers’ assessing jobs as “plentiful” relative to “hard to get” (from the Conference Board Consumer Confidence survey) are both well off their highs.

We continue to expect a recession and are underweight equities. Our conviction is now high enough that our Global Investment strategists have removed their barbell sector strategy (previously overweighting defensives + materials). They are now overweighting defensives outright. 

UK’s CPI growth stands right on the Bank of England’s (BoE) 2% target. However, services inflation remains sticky, growing at a constant 5.7% y/y in June. Moreover, the deceleration in wage growth remains insufficient to temper inflationary pressures in the services sector.

Our European Investment strategists had previously highlighted that a post-Brexit UK is subject to relatively stronger supply constraints than the rest of the world, while the fiscal response to the pandemic continues to foster an environment of excess demand. Both factors are contributing to sticky wage growth.

Both services inflation and wage growth need to decelerate in order to declare a sustainable return to target inflation. Despite striking a dovish tone at its June policy meeting, the BoE is therefore unlikely to cut rates in August, and likely to lag its G10 peers in easing monetary policy. Interest rate differentials are thus supportive of the pound in the short term.

However, GBP/USD hit a one-year high against the greenback and this cross broke above its key moving averages. Our FX strategists highlighted that net speculative positions are very long the pound relative to the dollar. They would fade any further strength in GBP/USD and recommend selling this cross if the 1.32 threshold is reached.

Total consumer credit rose by USD 11.4 billion in May (to USD 5,065 billion outstanding) from a slightly upwardly revised USD 6.5 billion increase in April, surpassing expectations of a smaller increase. Notably, revolving credit (which includes credit cards) accounted for nearly two-thirds of the rise in May and credit’s advances in May were the highest in three months.

The SIFI banks’ latest round of quarterly earnings calls also underscored that credit card lending continued to grow -- albeit at a modest pace. They reported that their retail customers otherwise evinced little appetite for credit.

A rise in consumer credit is noteworthy in an environment of a softening labor market and dwindling excess savings, given that it may contribute more to consumption growth than we expect. However, we continue to anticipate that a low willingness to lend will cap that contribution.

Lending standards respond to credit performance. Although credit card delinquencies remain low relative to history, they have been steadily rising. The soft-landing/no-landing narrative may still be dominating economic agents’ psyche and this optimism may still support lending. However, compensation growth remains the main driver of spending and credit performance. Lending standards will thus adjust to continued labor market deterioration.

The Q2 editions of the Senior Loan Officer Survey and the New York Fed report on household debt and credit are not yet available, but a sharp rise in transition into serious delinquency (along with weaker demand for loans and tighter bank lending standards across the board) had marked Q1. Given that economic conditions have been relatively stable since then, we do not expect any significant change in credit performance in Q2.