As summer gives way to autumn in the Northern Hemisphere, the reasons behind increased risks of hard-landings remain. First, due to the new deterioration of the global manufacturing cycle and, second, due to growing signs of fragility in the US labor market. As Julien HoudainHead of Global Unconstrained Fixed Income, Schroders in a long analysis in which he explains that “since last month we have growing concerns for the global manufacturing sector, with leading indicators such as the new orders components of the ISM manufacturing survey, the PEurozone MI and China Caixi PMIn which have fallen further from already weak levels.”
Bonds: risks of hard landing are growing
In Europe the automotive sector has weakened acDue to a combination of cyclical and structural forces, the outlook remains worrying for such a macroeconomically important sector.
Meanwhile, while the U.S. job market remains fairly robust today, “the risks of a chaotic worsening have increased. The breadth of job growth across sectors has shrunk to worrying levels, private sector job vacancies have declined significantly, and consumer confidence in the labor market has weakened.”
In absolute terms, explains the expert, nnone of these indicators are disastrous at current levels, and we are heartened by the fact that while job growth is slowing, actual job losses (based on initial jobless claims or layoff data) remain low. But the job market is not linear and by waiting for real weakness to appear before acting, you risk moving too late. The weakening we have seen in various metrics has already increased the risk that we are approaching a tipping point where a labor market recession is inevitable. We don’t think we’re there yet, but we’re closer than before and we would prefer not to get any closer.
but prospects remain positive
TO Jackson Hole, a few weeks ago, Fed Chair Jerome Powell shared this reasoning, recognizing the growing downside risks to the labor market and the room for maneuver, in terms of monetary policy, available to reduce them. In his economic outlook speech in late August he said: “The current level of our policy rate gives us ample space to respond to any risks we may face, including the risk of a further unwanted weakening of labor market conditions.” .
In other words: current levels are acceptable, further weakness is not. The Fed backed these words with action at its latest meeting. The market’s assessment that the Fed will react strongly to further bad news, while responding less forcefully to any positive developments, sIt means that there is a favorable wind for bonds in the medium term.
The difficulties of Europe
The highest probability we assign to a scenario of hard landing is was also determined by a more gloomy assessment of the prospects in Europe, especially in the crucial automotive sector. The manufacturing sector is particularly important for Europe and any global slowdown therefore has a particular impact. Furthermore, idiosyncratic issues related to structural changes in demand and competitiveness remain in the background, exacerbating thecyclical problems.
The service sector syou’re doing better, but it is simply not buoyant enough to offset the difficulties on the assets side. For example, even Spain – which has been the beacon of economic positivity of the Eurozone over the last twelve months – is starting to show signs of cooling in services, while the first signs of weakening are also appearing in the labor market.
Where to find the most interesting opportunities?
Despite the significant rally of the last month, “We remain positive on the outlook for bonds, thanks to the increasing probability of the hard-landing scenario, the growing macro risks and the asymmetric way in which central banks they will likely react to the data released. While entry points for long-term bond investments have become less attractive, we still seek to make the most of market declines by increasing the maturity of our bond investments where possible.”
In light of growing concerns about the Eurozone economy, duration in Europe has become a favored long. The ECB has begun its easing process, but has so far remained cautious, with only quarterly easing and extremely limited forward guidance. We believe that if the macro trajectory continues to soften, the possibility of the ECB becoming more dovish and easing monetary policy more quickly is significant.
We also believe that, under current market conditions, the difference between bond interest rates in the long and short term may increase: although this is a mostly global trend, Canada currently seems a particularly suitable place to express this trend, given the weakness of macroeconomic outlook and the central bank’s dovish stance.
