The American labor market figures point to a slowdown in the economy. However, the continued inverted yield curve is a cause for concern.
At first glance, it’s good news. The S&P 500 leading index immediately shot up at the opening of trading on Friday after the US authorities published the latest labor market data in the morning (local time).
The fact that American employers added fewer new jobs than expected in April gave cause for optimism. Instead of 241,000 there were only 175,000. This corresponds to the weakest increase in six months. The unemployment rate rose more than expected to 3.9 percent from 3.8 percent previously. From the perspective of financial markets, these data indicate a slowdown in the American economy.
This is a positive signal in today’s environment: it makes it more likely that inflation will return to a downward path after several months without declines. And it could allow the Fed to cut interest rates in the foreseeable future.
The euphoric expectations did not come true
But it’s not that far yet. The Fed will continue to keep its key interest rate at 5.25 to 5.5 percent for the time being, Chairman Jerome Powell announced this week.
According to data from the Chicago Futures Exchange, the financial markets do not expect the first interest rate cut until September. But not even that is certain.
A few months ago, the same data suggested six to seven interest rate cuts this year. These expectations have proven wrong.
Even experienced market observers – including the Fed itself – are currently struggling to make sense of the multitude of sometimes contradictory indicators.
Consumer price inflation in the USA has been persistent for several months. In March it was 3.5 percent compared to the same month last year. This value is well above the 2 percent targeted by the Fed. If the central bank cuts interest rates prematurely in this environment, it risks a resurgence in inflation, which Jerome Powell wants to prevent at all costs.
Investors are particularly uneasy about the still inverted yield curve: the interest rates on short-term American government bonds continue to be higher than the interest rates on long-term Treasuries.
This is a situation that cannot last forever: from an economic point of view, it makes no sense for a creditor to waive his waiting premium when granting long-term loans. Ultimately, with a longer term, he runs a higher risk that his debtor will not repay the amount owed.
Historically, an inverted yield curve is primarily a signal of recession. When it occurs, there is often an economic downturn, which allows the central bank to lower key interest rates and thus short-end interest rates.
A small recession?
But there is currently little sign of a recession. The American economy still grew at an annualized 1.6 percent in the first quarter of 2024. Johannes von Mandach, economist at Wellershoff & Partners, does not believe it is plausible that inflation rates will fall on their own if the economy is stable. “The best scenario from an investor perspective under these circumstances is a small recession combined with a decline in inflation. “The American economy can then strive for sustainable growth again,” says von Mandach.
The business consulting firm has been advising its clients for some time to reduce the risks in their portfolios and pursue a defensive investment strategy.
Thomas Stucki, head of investments at St. Galler Kantonalbank, also advises caution. “I don’t expect a recession. But now is the moment to take profits after the stock markets have done very well for a long time.” One possible approach for investors is to reduce the absolute value of a position back to the amount originally invested through sales. This is particularly useful for tech stocks.
Stucki notices increased nervousness on the markets given the uncertain initial situation. According to studies, the markets are reacting more sensitively to new inflation figures than they have for a long time.
Stucki describes a resurgence of inflation in the USA as an unlikely worst-case scenario. Such a constellation would force the Fed to raise key interest rates again above the current level. “That would massively increase the pressure on the stock markets.” In this scenario, according to Stucki, not just one, but several interest rate steps would be expected. But it doesn’t look like it at the moment, especially since Jerome Powell also describes this possibility as unlikely.
The starting position for the Fed is also politically sensitive: If the central bank only lowers interest rates in the fall, shortly before the elections, it could give the impression that it wants to favor incumbent Joe Biden. A non-reduction, on the other hand, could help Donald Trump, especially since some citizens are suffering from higher borrowing costs, for example for their mortgages or consumer loans. Whatever the Fed does, its decisions will likely be interpreted in the context of the election in the fall, even if Powell always emphasizes that the election campaign plays no role.
Swiss stock exchange hardly benefits from the first interest rate cut
Unlike the Fed, the Swiss National Bank (SNB) has already had its first interest rate cut. However, the SMI leading index has hardly benefited from this so far. Since the 20 largest listed companies such as Nestlé, Roche and Novartis primarily earn their money abroad, the Swiss franc exchange rate and the SNB’s monetary policy only play a minor role for them. “The stock market in Switzerland is also very strongly driven by the USA and the Fed’s monetary policy,” says Stucki, who expects the SNB’s next interest rate cut next September.