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"Even if the economy were to go into a recession, we have to get inflation down” – this statement from Cleveland Fed President Loretta Mester could not be clearer. Jerome Powell, Chair of the US Federal Reserve (Fed) said nothing less, albeit in more diplomatic terms, at the Jackson Hole Symposium of central bankers at the end of August. This warning reminded markets of an unpleasant reality after a summer of exaggerated euphoria: for a long time to come, central banks will no longer be providing support. This new situation has serious consequences, since investors have been accustomed to the world’s treasuries coming to their rescue at the slightest sign of weakness for over a decade now. For all that, while the impact of monetary policy is important, it is not the sole factor governing markets. It would be wrong to neglect another key factor – economic trends. And on this front, the outlook may not be so bleak, particularly in the US.
Firstly, let’s take a look at inflation. Alongside the monthly figures, it is clear that many elements are pointing to a gradual subsidence of inflationary pressure. As regards transportation – a major contributor to inflation in spring 2021 – we are seeing a steady decline in the price of second-hand vehicles and stocks of new vehicles being rebuilt, which should help stabilise prices. More generally, the gradual unblocking of the bottlenecks disrupting global supply chains in recent quarters should contribute to an easing of tension in consumer goods prices. The trend is also towards moderation in real estate, which has been the main contributor to inflation in recent months. Demand is falling both for transactions and financing, while stocks are being replenished. This situation will inevitably feed through into a decline in real estate inflation in the coming months. Lastly, strong US dollar appreciation versus most currencies should result in deflation in the cost of imported goods.
The prospect of these downwards drivers on inflation represents good news for economic stakeholders. However, there are some other less positive factors, including stagnating consumption, the risk of overstocking that is appearing, and a negative wealth effect from the imminent fall in real estate prices. But the US economy has a number of safety nets available today. Firstly, households are only just starting to dip into the very large savings reserves built up during the Covid-19 pandemic. Secondly, taken as a whole, neither families nor companies are overly indebted and corporate profitability has stayed at a high level to date. And lastly, the labour market remains rock solid. Jobless claims are rising very modestly and initial claims have been declining for several weeks. Job vacancies are still high compared with the number of jobseekers, while job creation remains sound with more than 300,000 jobs created in August.
We may be walking a tightrope, but economic data means that we can continue to hope for a soft landing, i.e. a scenario where the Fed will see its monetary policy through without causing a bigger slowdown in the US economy than that seen in recent months. This would be the ideal backdrop for the stock market to rediscover some forwards momentum on the basis of sound fundamentals.
2 September 2022 – Enguerrand Artaz, Fund Manager and Olivier de Berranger, CIO, LFDE