The Month Ahead

As at 23 August US equity markets have made gains this month, with the S&P 500 Index up 2.2% (with five days left to go). At one point, however, the broad-based index was down by as much as 6%, as July’s employment report showed unemployment rose to 4.3%, the highest level since October 2021, and the number of jobs created was well below expectations. It raised fears the US economy could be headed for a slowdown – and perhaps even a recession.

The falls were exacerbated by a sharp sell-off in Japanese equities, which saw the Nikkei 225 Index down more than 19%. This was a result of the unwinding of a popular ‘carry trade’, where investors borrow in a low-cost currency (such as the yen) to invest in higher-yielding currencies, shares and bonds. The unwinding of this trade was triggered by the Bank of Japan’s decision to lift interest rates. The good news is that Japanese equities subsequently enjoyed a strong rebound, which has allowed them to recover almost all those losses.

New Zealand equities have continued to push higher, buoyed by an interest rate cut from the Reserve Bank of New Zealand (RBNZ) – the first one since March 2020. The NZX 50 Index is up 1.0%, as investors have taken the cut to suggest the period of high inflation is over and this is a first step to removing a key headwind to economic growth.

Global government bond markets were also higher, lifted by the prospect of interest rate cuts from the US Federal Reserve (the Fed), one of few major central banks not to have begun easing monetary policy.

As we head into September, inflation and central bank policy remain key. Geopolitics is also something to watch, while the US election starts taking centre stage and simmering Middle East tensions.

Key dates for the diary are 17-18 September, which is when the next rate-setting meeting of the Fed will be held to decide on the future path of monetary policy for the US economy. Recent inflation readings have bolstered hopes that a ‘soft landing’ is possible, with other economic data helping to alleviate recessionary fears which prompted the sharp sell-off early this month.

Annual headline inflation in the US (as measured by the Consumer Price Index) was 2.9% in July, its lowest rate since March 2021. Meanwhile, retail sales for July came in stronger than expected and weekly jobless claims fell – both offering evidence that the recession fears are overblown.

With inflation gradually drifting back to target level, the Fed has indicated a willingness to ease, especially with the focus shifting to the labour market – the other side of its dual mandate (i.e. pursuing the economic goals of maximum employment and price stability). Money markets agree that policy easing is appropriate and have moved to fully price in a quarter percent rate cut in September.

The RBNZ cut interest rates by 0.25% in August to 5.25% and indicated that further easing is likely – assuming inflation continues to trend back towards the central bank’s target rate. The central bank projects interest rates at the end of the year to be at 4.9%, whereas money markets expect even more in the way of cuts.

With the next meeting of the RBNZ not until 9 October, we have some way to go before further decisions are made. Some of New Zealand’s key data surveys are quarterly, such as inflation, growth (GDP) and employment, meaning we have a bit of a wait to see how things are tracking in that regard.

So, the focus will likely be on a range of other high-frequency indicators to get a better steer on the state of domestic economic activity. This includes business activity, electronic card transactions, house sales, filled jobs and job vacancies. It will start with consumer confidence and ANZ Business Confidence in the coming days, both of which will give a steer on the state of the household and business sectors.

Kamala Harris has formally accepted the presidential nomination for the Democratic Party, setting up a showdown between herself and former President Trump as they head towards November’s vote. Attention will now turn to a number of televised debates between the two, the first of which is scheduled for 10 September. The Democratic Party will be hoping for an impressive performance from their candidate, following President Joe Biden’s disastrous performance in June’s debate, which prompted the calls for him to step aside.

Beyond the US, other geopolitical events are likely to gain attention. Following France’s election in July, there’s still no prime minister for the country, with President Emmanuel Macron yet to appoint a new leader who can appeal to both the left and the right. Ukraine has been making inroads by encroaching into Russian territory, something which is likely to be untenable for the Russian President Vladimir Putin. And finally, tensions continue to simmer in the Middle East, with Iran-backed Hezbollah recently launching rockets and drones against Israel in retaliation for the killing of its top commander in July.

We made no changes to our tactical positioning in August, maintaining our overweight position to New Zealand and international bonds, a neutral position to equities, listed property and listed infrastructure, and an underweight to cash.

Our base case remains for the US to achieve a soft landing, meaning inflation there should track back to target level with growth remaining somewhat resilient. This would allow the Fed to begin dropping interest rates accordingly. While this may mean equities continue to head higher, we maintain a neutral weighting to the asset class – given the geopolitical backdrop, and where, despite the recent sell-off, many technology stocks remain above their 50-day moving averages – suggesting they’re not yet in oversold territory. Meanwhile, we favour fixed interest, as central banks continue to ease monetary policy and should bring interest rates lower.