On the one hand…
The global economy is still growing, central banks continue to follow an accommodative monetary policy, inflation risks appear to be muted for now and employment statistics continue to show record numbers employed. Company CEOs have also been very successful in reducing earnings expectations to such a level that there could be a significant number of positive surprises around earnings season.
…on the other
However, this does not paint the whole picture. The counter view to this rosy outlook is that while economies are still growing, they are doing so at a slowing rate. The yield curve has already inverted twice this year, which has historically been a good predictor of future recessions. Although equity markets may be reflecting a positive outcome, bond markets are indicating almost the exact opposite. Yields this year have tumbled at a startling rate, suggesting in part that inflation expectations for the future have dropped even further but also that the economy may be due a significant correction.
Our view is that the bond markets are probably pricing in too pessimistic a scenario, as prices have overshot underlying economic fundamentals. We would expect yields to back up from here, but to remain fairly muted going forward. Expectations of rate cuts by the market are also, in our view, slightly overdone. Although it appears that a 0.25% cut will be delivered by the Fed at the next meeting, expectations of a 0.5% cut look overly optimistic. With US inflation below 2%, there remains pressure, not least from President Trump, for more accommodative policy. Wage inflation continues to move higher at a slow pace but will take time to pass through to core CPI. A more sudden pick-up in inflationary pressure would lead to expectations of another policy reversal from the Fed and a tightening in financial conditions, which would be a headwind for equity markets.