Improving economic data supports rising consumer demand.

Welcome to this month’s edition of the True Potential Monthly Report. Within this, we discuss asset markets and the macroeconomic environment. Below is our Executive Summary.

• Helped by strong consumer spending, the US economy is proving more resilient than many expected.
• Monetary policy is no longer ‘tight’; this is boosting household income and corporate profits.
• After the first US rate cut for four years, bond markets are positioned for further cuts in the near term.
• We favour equities over bonds, with a preference for high-quality US and UK stocks.
• In the bond markets, we prefer UK gilts and high-yield corporate bonds.

Further Detail

Improving economic data suggests that we may have been too cautious in our outlook. Driven by robust consumer demand, the US economy is still growing at a faster-than-average rate. In the Eurozone, however, Germany’s economy contracted in the second quarter and is dragging down the region’s overall growth. Across the G7 countries, governments are borrowing to stimulate their economies, but unemployment is rising. The context for this rise is important, however: jobs aren’t being destroyed, but record economic immigration – especially in the US – is causing unemployment to rise as job growth slows. This should mean that wage growth will continue to slow too.

It’s also important to note that monetary policy is no longer ‘tight’. The height of the recent round of monetary tightening came the first half of 2022, when both G7 interest rates and the price of goods were at their peaks. Now, however, high real rates (e.g. interest rates that are higher than inflation) are helping households with high levels of savings and companies with high levels of cash. Meanwhile, the falling prices of raw materials are reducing companies’ input costs. So, as households enjoy higher real incomes, consumer demand is rising, and corporate profit margins are at or around all-time highs.

Fixed-income markets, which are driven by US Treasuries, are currently priced for ‘perfect’ disinflation: a scenario in which the economy slows without entering recession and without higher inflation. This would allow central banks to lower interest rates significantly. Further interest rate cuts from the Federal Reserve are likely this year.  Should the US economy remain strong in early 2025 then fewer cuts may materialise thereafter.

We continue to favour an overweight position in equities and a modestly reduced exposure to sovereign bonds. Within equities, our preference is for high-quality stocks in the US and UK. In fixed income, we prefer UK gilts and high-yield corporate bonds.

All data sourced from Bloomberg L.P. (30/09/2024)