Quarterly Investment Strategy
United States - Neither inflation, nor recession
Although macro data has been choppy of late, the US economy remains on a positive track with no obvious signs of overheating. Most metrics that could suggest such a development (i.e. consumer and producer price indices, commodity markets, US dollar, wage growth, bank loans) still remain well below long-term norms. In particular, there has been no upturn in inflation during the last few months.
A number of reasons can be found to explain why the improvement in employment has not led to faster wage growth, and consequently price inflation. The US labour market is perhaps not as tight as generally believed. Demographic changes over the past decade, notably the retirement of baby boomers, may be reducing the pressure on wages. Since NAIRU (the non-accelerating inflation rate of unemployment) is but an estimate, it could be understating the slack in the labour market. And low productivity growth technological change, globalisation, part-time employment and diminished worker bargaining power also all contribute to a flattening of the Philips curve.
While the robust economic conditions will certainly allow the Fed to pursue its policy tightening, the absence of overheating signs should serve to limit its actions. In our view, the peak of the rate hiking cycle is not far away – with balance sheet management to take over from that point.
Conversely, what about the risk of a recession in the US? None of the macroeconomic and market measures that we monitor are sending such a signal for now, with service activity particularly solid. Some concern has been expressed about the flattening of the yield curve during the last few quarters. We would counter that, historically, recessions were preceded by an inversion – not just a flattening – of the yield curve. The extraordinary monetary policies of the past eight years may have affected the yield curve’s signalling ability but, until proven otherwise, it is only inversion that counts. The US economy thus appears at the very least 12 to 18 months away from recession.
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