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Will there be a soft landing, a hard landing, or no landing for the economy?

Global yields rose in the past week in the wake of last Friday’s exceptionally strong US jobs report. Payrolls data can be erratic and January was helped by mild seasonal weather this year. However, with back-dated revisions also adding a significant number of jobs, the broad picture coming from the US labor market remains robust, notwithstanding anecdotal reports of rising job losses in some sectors.

Traveling in the US in the past week, there still seem to be plenty of signs of employers seeking staff. Recent estimates have highlighted that those companies that were losers during the Covid pandemic are still nearly four million jobs short compared to their pre-pandemic trend, even as those that were relative winners seem to have close to one million employees in excess of their prior trend.

In part, we may see tech workers taking positions in branches of Chipotle (CMG), but nevertheless, there seems little to point to slowing activity when focusing on labor market dynamics at the current time.

Elsewhere, some interest rate-sensitive sectors of the US economy have slowed materially. Yet, taking housing as an example, the fact there has been little over-building in recent years means that inventories are light, and consequently, it is difficult to project this being a very substantial drag on overall economic activity as a whole.

Moreover, as the Fed surveys the landscape, it strikes us that there is not much to push them away from recent messaging, and where markets have discounted early rate cuts as soon as rates hit a peak, so there may be scope for further re-pricing as market expectations, which had diverged from the Fed's view, come closer into line.

During January, it appeared that financial markets were operating with a Goldilocks mentality, looking for a soft landing for the economy, which may represent a boon for asset prices. Although we can see a scene where this occurs, there are other scenarios that also remain on the table in our assessment.

In that context, hopes for a soft landing a few weeks ago appears replaced by a concern there is no landing at all in February, with growth not slowing for the time being, thus inferring a more hawkish path for interest rates. Yet, economic data will hold the key to settling this debate and in this context, attention will now shift toward next week's crucial US CPI report.

After last month's benign inflation data, we think the incoming data may be a bit stronger over the next couple of months. This will see the annual rate move lower, but maybe not as quickly as some have been hoping. That said, there remains substantial volatility around individual data points, and with the Fed and the market both in data-dependent mode, so such surprises will hold the ability to drive markets in both directions.

Treasury yields remain higher than they were at the start of the year and we also think that a deeply inverted yield curve only makes sense once it is clear that economic activity is slowing in response to tighter policy. We continue to maintain a short stance, though were we to see yields at the levels of last December we are inclined to flatten out risk.

Meanwhile, European markets have been trading in a similar fashion to the US. The ECB remained hawkish last week and it seems that the risk to interest rates remains tilted to the upside. With heavy supply also set to be an ongoing feature we see this weighing on bond yields, meaning we have similarly favored a short-duration stance.

It was also an important week in Scandinavia, with both the Riksbank and the Icelandic central bank delivering hawkish outcomes at their respective meetings. Plagued by a string of ugly inflation prints, both central banks were under pressure to restore market confidence after seeing their respective currencies fall sharply over recent months. Challenges remain ahead, notably housing in Sweden and a potential wage-price spiral in Iceland, but we think the forceful actions of this week should limit any further downside in the Scandi FX space for now.

In Japan, academic and former Bank of Japan board member Ueda is set to be appointed as a new governor, after the favorite, Amamiya, declined the role. Often, the market can get fixated on whether this is a ‘dovish’ or ‘hawkish’ move, missing the underlying political and economic direction. Data is showing a sharp acceleration in wage compensation to 4.8% in December and is yet another reminder that economic conditions are what will force the BoJ to act, rather than an individual personality or external pressure coming from the market.

Anecdotal reports suggest some large companies could offer workers a double-digit pay increase this year, and in our assessment, we think the spring Shunto wage round may end up stronger than many in Tokyo currently expect.

Broadly speaking, a lot of complacencies seems to remain in how ultra-accommodative monetary policy can feed building inflation pressure in Japan, and from this point of view, we think that yields will push higher in the months ahead.

Evidence of a rapid normalization in activity in China can also help add to the constructive growth narrative in the coming weeks. It will be interesting to see whether Chinese consumers rush to spend pent-up savings they have been accumulating and whether this could have a somewhat inflationary impact, as witnessed elsewhere.

Recent policy stimulus from Beijing also points to a strong bounce in activity, even though we continue to believe this may peter out as we move through 2023, with the underlying economy still impacted by structural negatives.

Elsewhere, credit markets have retraced a little, along with equity markets in the past week, in response to higher government bond yields. At the end of January, we pared directional exposure credit spreads, favoring a policy of reducing risk as spreads rallied and adding hedges via CDS indices.

A somewhat more material reversal was seen in FX in the past week, with the dollar rebounding from recent lows in the wake of data forcing a reappraisal of the underlying strength of the US economy and the likely trajectory of short-term rates.

At this juncture, we do not have a strong directional view on the dollar, with FX trading more relative value in nature. We remain bearish on the pound while retaining a constructive stance in the Swedish and Norwegian krone, which appear materially undervalued on a relative basis.

We have cut the long in Hungary, though retain a stance long Japanese yen versus the Swiss franc. Elsewhere we have few EM currency positions for now, with a short position in the Philippine peso.
 

Looking ahead

All eyes will be on data in the week to come. As we ponder this, we continue to observe how markets can act with a herding mindset. In this way, there may be cries of a soft landing in one moment, a no landing the next, and a hard landing shortly thereafter.

In our assessment, all possibilities remain on the table and it is best not to get hysterical and look for opportunities to take a contrarian view if any particular outcome is priced with too much certainty.

Policymakers we speak to are similarly uncertain of the data trajectory, meaning that forward guidance has limited merit at this time. In this context we are eager to adopt a flexible stance, remaining ready to adjust to incoming information.

That said, in a week when the US shot down the Chinese moon balloon, it may be tempting to reflect on how suddenly things can fall back to earth with a bump. After all, we have always been taught that what goes up must always come down.

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