Recent USA Economic Data Drives Decline in Interest Rates:Lisa Shalett’s Global Investment Committee report
A recent softening in USA economic data, including a cooling job market and slower consumer spending, has driven a significant decline in interest rates. The 10-year Treasury yield has fallen about 20 basis points since the end of May, while the 2-year yield fell about 10 basis points.
Market Reaction and Overconfidence Concerns
The stock market’s immediate reaction has been to rally to new highs, fueled by heightened expectations for Federal Reserve rate cuts and confidence in an economic “soft landing,” where growth slows and inflation eases. However, Morgan Stanley’s Global Investment Committee believes markets may be overconfident in this outcome. The recent data continues to present an unclear picture of the economy’s direction, particularly concerning the labor market. Investors hoping that a cooling job market will lead to lower interest rates might be overlooking the risk that a rapidly cooling job market could push the economy into recession.
Labor Market: Cooling Down or Heating Up?
The Job Openings and Labor Turnover Survey (JOLTS) data for April, which showed declines in job openings and the quits rate, encouraged markets by suggesting a cooling labor market. However, the May non-farm payrolls report contradicted this, showing that USA employers added a forecast-beating 272,000 jobs, even as the jobless rate rose to 4%, the highest since early 2022. Additionally, wage growth re-accelerated to 4.1%, indicating upward pressure on prices and potential risks to corporate profit margins. With such mixed data, it’s challenging to share the market’s apparent faith in a soft landing.
Reasons for Caution
A closer examination of the JOLTS data suggests that the labor market may be quickly normalizing to pre-COVID conditions, raising the specter of a recessionary “hard landing.” Key indicators include:
– Job openings are now below their 20-year trend.
– The hiring rate has fallen to 3.6%, down from an average of over 4% in recent years.
– The ratio of job openings to job seekers is back to 2019 levels.
– The quits rate has declined to levels seen between 2016 and 2019.
If these trends continue, any further decline in job openings could quickly increase the unemployment rate and heavily impact consumer spending, which drives about two-thirds of USA gross domestic product. Currently, with lower-income consumers depleting excess savings and maxing out credit, spending may increasingly depend on a robust job market.
Implications for Investors
Given the uncertain outlook for the labor market and broader economy, our recent recommendations remain unchanged:
– Focus on portfolio diversification and active stock-picking.
– Look for companies with quality cash flows and achievable earnings targets.
– Consider using “call” options on the CBOE Volatility Index (VIX) and “put” options on the S&P 500.
Investors should also consider non-USA investments and real assets—such as gold, real estate investment trusts (REITs), master limited partnerships (MLPs), and commodities—as potential portfolio diversifiers. Increasing portfolio allocations to investment-grade credit may also be prudent.
