Week 46

Macro

Initial jobless claims in the United States fell by 6,000 to 213K, beating expectations of 220K and reaching their lowest level since April. At the same time, however, continuing claims rose by 36K to 1.91 million, the largest increase in three years, suggesting that overall demand for workers may be softening.

Despite this mixed signal, the labor market remains relatively strong. The unemployment rate stands at 4.1%, and job growth appears stable once hurricane-related distortions are considered. Nonetheless, the pandemic has left its mark, driving a significant shift toward remote work, which increased from just 5% to 30% of the U.S. labor force.

A growing number of analysts have adopted a “no-landing” outlook for the economy. In remarks delivered Thursday in Dallas, Federal Reserve Chair Jerome Powell highlighted the economy’s resilience, ongoing growth, and robust job market. He indicated there is currently no urgency to cut interest rates, noting that while inflation has eased substantially from its peak, it remains above the 2% target.

This environment is complicated by sustained government spending at a time of economic expansion and restrictive monetary policy. With federal spending at 23.3% of nominal GDP, economists are expressing concern that continued fiscal stimulus could offset the effects of tightening monetary conditions.

Citibank and Bloomberg’s economic surprise indexes have been increasing since August (the index bottomed at the end of June), showing a surprise to economic expectations. The economic surprise index takes all the economic data for the month, compared to the economists’ median expectations, and calculates it as the exponential weighted average of the six months. Bloomberg breaks down the index further and points out that surprises are driven by the strength of US retail.

A fund manager survey points to the dramatic shift in fund managers’ views on the US economy. Before the election, 76% of managers expected a soft landing and 14% no landing; now, only 55% are in the soft landing camp and 33% are in the no landing camp.

  • 2.5% – no landing – the economy is growing at its full potential (natural growth rate without stimulus or pushing on the breaks)
  • <2.5% > 0% – soft landing – the economy is growing but below its full potential
  • < 0% – hard landing – recession with negative GDP number

The speculation of how the new administration will impact the economy continues.

Rates

Traders are becoming less confident about the December rate cut. This year, the market has been rapidly adjusting its rate cut expectation; however, over the last three weeks, the probability of the year-end cut has remained flat. The upward rate movement reflects that the market rejects the idea that rate cuts are necessary.

After the election, bond market volatility dropped, bond market volatility declined, with the MOVE Index dropping from 135 to below 100. As the 10-year Treasury yield hovers near 4.5% in what many still consider a rate-cutting environment, fixed-income investors see potential opportunities. However, there is a risk that the market could once again reject the likelihood of Fed cuts, pushing inflation expectations and yields even higher.

The market’s stance is now quite hawkish, factoring in tariffs and inflation expectations while recognizing that the Federal Reserve still has a distance to cover before reaching a neutral rate. On Thursday, Fed Chair Jerome Powell stated, “The economy is not sending any signals that we need to be in a hurry to lower rates. The strengths we are currently seeing in the economy give us the ability to approach our decisions carefully.”

Since the 10Y is now close to 4.5% in the rate-cutting environment, it creates a new opportunity for fixed-income investors. The risk is that the market could reject the FED rate cuts again and increase their inflation expectations by pushing rates higher.

Recent changes in the 2-year/10-year yield spread reflect shifting inflation expectations and associated risks. At the start of the week, markets were pricing in an 80% probability of a December rate cut, but that figure has since declined to 60%. The terminal Fed funds rate forecast has also been slightly adjusted.

Credit

The global credit market remains optimistic, pushing spreads to historic lows. Investment-grade spreads in Europe have now fallen below 100 basis points, and across developed markets, opportunities appear exhausted as spreads converge. High-yield bonds are nearing their tightest spreads since 2007, and overall credit spreads have returned to levels last observed just before the Global Financial Crisis and the dot-com bubble.

Strong yields offered by fixed income markets have attracted consistent inflows across the investment spectrum. Now that the U.S. election, a major risk event, has passed, investment-grade spreads have tightened further to around 78 basis points. Early policy proposals from the president-elect are viewed as supportive for corporate issuers, reinforcing the positive backdrop.

These historically tight spreads—last seen just prior to the GFC and the dot-com collapse—suggest that the market is approaching an extreme threshold. Persistent yield-seeking behavior continues to drive steady inflows into fixed income.

Nevertheless, inflationary pressures remain the primary risk for the credit market. The latest SLOOS survey (Senior Loan Officer Opinion Survey) has, for the first time in two years, shown a neutral reading, indicating no further tightening in lending standards.

Equities

With President Trump’s election, many investors anticipate a revival in the M&A market. As electoral uncertainty has lifted, a resurgence in the IPO market is also expected. Notably, this year’s IPOs have performed well, with a weighted average return of over 15%. The largest IPOs saw the best returns, with more than 100 IPOs in total. Among them, 16 were SPACs (Special Purpose Acquisition Companies), marking a comeback after their collapse in 2022.

At the start of the COVID-19 pandemic, SPACs rose in popularity as low interest rates and market volatility made traditional IPOs less attractive. Companies found that merging with SPACs offered a faster and potentially simpler path to going public, facing fewer regulatory hurdles. Although the SEC has tightened rules around financial projections, and many investors have suffered losses, experienced industry figures remain committed to launching new SPACs. While the market is still quiet, issuers believe conditions are turning and are filing for new SPACs to prepare for upcoming opportunities.

Analysts often point to American exceptionalism because the U.S. market has outperformed other developed and global equity markets since the financial crisis. However, if we start the comparison from the year 2000, real returns on U.S. equities average a solid, though not extraordinary, 4.9% annually. In fact, Australia, India, and South Africa have outpaced the U.S. over this period.

A key factor is the valuation environment at the turn of the millennium. By 1999-2000, U.S. stocks were trading at extremely high multiples, and their valuations today are once again nearing those lofty levels. The takeaway is clear: if prices remain this stretched, it’s unlikely that U.S. equity returns over the next 25 years will match the standout performance of recent decades.

Since the elections, markets have embraced risk assets, with equities, credit, bitcoin, alternatives, and real estate all moving higher. The SPY ETF saw $18 billion of inflows during a nine-week streak—the longest since 2014. Additionally, companies have repurchased a record $1,105 billion of their own stock. Meanwhile, Morgan Stanley’s S&P 500 Equity Risk Premium measure is at its lowest point since the dot-com era, signalling that stocks appear richly valued. However, this metric has been misleading in the past.

The U.S. election has also had some negative impact on European equities. Overall, the equity market’s current focus is on earnings season, with next week’s Nvidia report considered potentially more influential than upcoming CPI data or job market figures.