Macro Matters: A Tightrope Between Inflation and Yields

Our economic outlook

U.S. growth began to slow in the third quarter, with real consumer spending showing as flat and retail sales declining. Consumer confidence indicators also point to a pullback in sentiment. Households are growing more cautious about the labor market despite policymakers’ view that we are at neutral employment levels.

Artificial intelligence (AI) continues to be a dominant driver of U.S. growth, accounting for roughly one-third of the current year-over-year increase in the U.S. gross domestic product (GDP) rate and making up the lion’s share of nonresidential private fixed investment. By contrast, all other forms of nonresidential construction are flatlining. This poses a challenge for policymakers, in an environment where fiscal policy has dominated outcomes and stimulative measures are beginning to level off. In our opinion, this means that monetary policymakers are “stuck.” We expect inflation to remain sticky above target, further complicating the economic outlook.

Outside the U.S., China’s second quarter GDP growth came in at 4.3% year over year, well below the government’s annual target. Industrial production continues to drive China’s economy, but consumer demand remains subdued as the negative wealth effects from the property market bubble persist. Beijing is beginning to ease fiscal austerity, with fewer cuts to government spending and a coordinated package of fiscal and financial support measures potentially on the horizon. The EU remains in a tricky position. China’s trade surplus to the EU region has reached another record high, while the European economy is struggling with sluggish productivity growth and limited policy maneuverability.

Prospective changes to asset allocation:

• Equities
  Risk appetite remains constrained by elevated real yields and ongoing geopolitical uncertainty. Second quarter earnings were robust across sectors. Despite a strong earnings season and constructive forward guidance from AI-related sectors, the market is seemingly beginning to question the potential of return on invested capital. Earnings beats and better-than-expected guidance are no longer providing the same tailwind to the AI theme as they once did. We maintain a positive view on broad-based U.S. equities and the eurozone, supported by continued strong valuations. In Japan, we are refining our view further and moving toward more robust allocations within the financials sector.
• Fixed income
  Real yields are beginning to look more attractive. However, with no immediate monetary or fiscal catalyst on the horizon to push nominal yields lower, we remain neutral on U.S. duration and continue to be underweight the long end of the yield curve. Rates in developed ex-U.S. markets are currently elevated and volatile, but attractive all-in yields are creating compelling opportunities for longer-term entry points.
• Commodities and foreign exchange
  We continue to favor commodities while broadening the opportunity set. Within energy, we still prefer relative value exposures over directional positioning given persistent geopolitical uncertainty. We are constructive on industrial metals and favor a modest overweight to agricultural commodities as underlying fundamentals soften. Within currencies, we remain positive on select economies supported by favorable growth dynamics, orthodox monetary policy, and attractive starting interest rate levels.

Multi-asset allocation views:

These multi-asset views reflect tilts to our strategic asset allocation models and are based on a 6- to 12-month time horizon, driven by both quantitative and fundamental research.
+ (Overweight on overall asset class)    
= (Neutral on overall asset class)  
– (Underweight on overall asset class)

Forward investment implications:

The Atlanta Fed’s gross domestic product (GDP) tracker (formally called GDPNow) is a real-time estimate of U.S. economic growth produced by the Federal Reserve Bank of Atlanta. It is a model-based, continuously updated forecast of real U.S. GDP growth for the current quarter, expressed at an annualized rate.

Carry refers to the net return earned from holding an asset over time, independent of price movements, after accounting for the costs of financing or maintaining that position.

Curve steepener refers to a change in the yield curve where the difference between long-term interest rates and short-term interest rates increases, making the yield curve steeper.

Duration is a measurement of the sensitivity of a bond’s price to changes in Treasury yields. A fund’s duration is the weighted average of duration of the bonds in the portfolio. Duration should be interpreted as the approximate change in a bond’s (or fund’s) price for a 100-basis-point change in Treasury yields. Duration is based on historical performance and does not represent future results.

Hedging a bond means using a separate investment to offset the potential risks of the bond.

The Nikkei Stock Average (Nikkei 225) is composed of 225 stocks selected from domestic common stocks in the first section of the Tokyo Stock Exchange and is a leading benchmark for Japanese equities.

The Personal Consumption Expenditures (PCE) Price Index reflects changes in the prices of goods and services purchased by consumers in the U.S. It is part of the Personal Income and Outlays Report issued by the Bureau of Economic Analysis of the U.S. Department of Commerce. You cannot invest directly in an index.

The Purchasing Manager’s Index (PMI) is an economic indicator that measures the health of a country’s manufacturing or services sector.

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Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

This material is provided for informational purposes only and is intended for retail public distribution in the United States. Use outside the United States is for professional/qualified investors only.

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