Many people now believe US economic conditions are right for a "soft landing" as inflation continues to decline. Hence, investors expect that this week's US Federal Reserve interest-rate increase will be the last one for the rest of the year.
Inflation has also declined in Europe and the UK. In short, it seems that the need to speed up rate hikes is diminishing.
However, taking a closer look, economic indicators send worrisome signals. The latest Conference Board leading economic index, used to predict the US business cycle about seven months ahead, declined for the 15th consecutive month in June as consumer expectations fell.
Key components of the index also deteriorated: new orders weakened, the number of people claiming unemployment benefits rose and housing construction fell.
Also, the July preliminary composite Purchasing Managers Index (PMI) readings in the big economies such as the US, Europe, UK and Japan were also weaker than expected. The manufacturing sector contracted more strongly while the service sector slowed further, indicating that developed economies will enter a "synchronised slowdown".
This is in line with our view that it is too early to say that the global economy is moving towards a soft landing, even with US inflation falling to 3% in June, making the Fed's rate hike on Wednesday the last for this year.
Other central banks such as the European Central Bank may raise rates one or two more times, causing rising stock prices, falling bond yields and a weakening dollar.
However, the US and global economies still remain vulnerable to recession due to three risks. First, inflation in developed economies will remain high. Although the 3-4% rate in the US is not as severe as the 8-9% levels seen over a year ago, it is still a problem for the central bank, and may require tighter monetary policy than expected.
LABOUR MARKET COOLING
The second risk is the US labour market, which has begun to cool. While unemployment remains relatively stable and near an all-time low, it may start to increase. The cause will not be layoffs, but a decline in new job openings, which is already being seen.
This trend has emerged because companies still have scars from the labour shortages the experienced after opening up post-pandemic; hence they have been "hoarding" workers they don't immediately need. In several countries average hours worked have been falling. But if companies decide it's too costly to hire workers who may or may not be needed in the future, layoffs could then rise significantly.
The third risk is the disparity between the world's major economies. Even as pressure on the Fed has eased, policymakers elsewhere are still concerned. In the UK, for example, inflation at 7.9% was lower than expected in June but still uncomfortably high, causing the Bank of England to continuously raise interest rates.
Japan, meanwhile, has just begun to tighten its finances. With inflation rising, the Bank of Japan may end its yield curve control measures soon. In China, where consumer price inflation in June was zero, there is a rising risk of secular stagnation and a deflationary spiral, as Japan faced in the early 1990s.
In our view, US inflation will not be able to decrease rapidly in the future. This is because the current components of inflation (rents and wages) are more sticky than in the past. As well, it will be harder to respond to a decline in commodity prices, which would force the Fed to hold interest rates high for longer.
Second, tightening liquidity due to high rates will put pressure on purchasing power and deplete excess savings. This will reduce sales volumes and cause businesses to start cutting workers. Thus, the unemployment rate will increase in the future.
Third, monetary policy is still tight around the world. In addition, an important economy like China is slowing more than expected due to deflation. These factors will pressure the global economy to slow significantly in the second half of the year.
SHORT-TERM STRATEGY
Amid the gloomy outlook for the global economy, our investment strategy in the next three to six months is as follows:
- With respect to debt instruments, we recommend investing in government bonds, especially US Treasuries. This is because if the economy slows down as we expected, bond yields will decline. This makes investing in government bonds attractive. Investment-grade corporate bonds are also an option, but high yields are risky, in our view.
- Among equities, we are underweight in developed markets, while keeping a neutral weighting in Japan, China and Thailand. Nevertheless, we believe some stocks in the US still have potential and are worth investing. We recommend a "barbell" strategy to buy/hold shares in defensive stocks, and also some growth stocks, especially in the technology sector.
- Among alternative assets, we have a neutral weighting in real estate and real estate funds in developed countries. But we are overweight on Thai and Asean real estate investment trusts (REITs), for which dividends will be better in line with the economic recovery, in our view. Oil prices, meanwhile, have started to rise as the Opec+ group continues to control output to stabilise the price. This is a short-term investment opportunity in our view. We also recommend holding some investments in gold to cushion against rising risks in the second half of the year.
Good luck to all investors.
Dr Piyasak Manason is senior director of the Investment Strategy Department, INVX-Research Group, at InnovestX Securities Co Ltd.
