At the end of last week, Federal Reserve (Fed) Chair Jerome Powell delivered his latest speech on the outlook for the US economy at the Jackson Hole Symposium. He confirmed that rate cuts would begin in September and highlighted that the Fed will not tolerate any further cooling in the labour market. Powell didn’t commit to the likely pace or depth of the cutting cycle but he did say they had ample room to cut in the event of downside risks. Now that the cutting cycle is confirmed, the number of cuts we will see will be determined by data – specifically the US labour market.

Looking ahead, we expect a relatively healthy pace of growth in the US for the rest of this year and into 2025. Earlier in the summer, we nudged down our growth view slightly due to softer incoming data. However, we are of the view that the period we are currently going through is more akin to a ‘mid-cycle slowdown’ than signalling a looming US recession.

US consumer remains resilient

Reflecting this view, we see inflation settling at a steady run rate, resting above the Fed’s target and with core elements remaining ‘stickier’ for longer. What this means is that the Fed can begin to cut rates in September but will likely deliver a fairly shallow cutting cycle. This view is aligned with an economy that can handle higher short-term neutral interest rates relative to the years between the 2008 global financial crisis and the 2020 pandemic.

Importantly, we see the Fed’s actions as pre-emptive and stimulatory for the US economy at this stage. Like the significant loosening in financial conditions that was seen across markets in Q4 last year – we think that market pricing of lower rates and ongoing tight credit spreads will help growth to continue and avoid a spike in unemployment. Although the weaker July payrolls data and ongoing employment weakness in manufacturing surveys increased market concerns of more visible cracks emerging in the labour market, our assessment of the data on aggregate shows that other employment metrics aren’t signalling significant weakness and the US consumer remains resilient.

Tight contest will mean difficult for markets to price until event itself

The US election is a key risk event. At the time of writing, Harris is now the favourite in the prediction markets, overtaking Trump. In reality, we have gone back to when Biden and Trump were neck and neck only a few months ago. This will be a tight contest, dependent on a handful of swing states. Given the tightness of the contest, it will be difficult for markets to price until the event itself, allowing events such as the first Fed cut to have more importance on a shorter-term basis. However, we have also observed that the ‘Trump Trade’ has been faded by the market and in our view this may provide some opportunities in terms of effective hedges for the election.

See scope for equity markets to relief rally regardless of winner

Our base case is a split congress – which will help dilute some of the agendas from both parties. However, we see the Republican agenda as more inflationary. Even if there is a split congress, the President’s ability to pass executive orders on tariffs and immigration, means that a Trump-led US will likely see the inflation risk return to markets and could mean a higher term premium for long end Treasuries. We think equity markets will like the Republican lower tax agenda but we also see scope for equity markets to relief rally regardless of who wins, once the initial uncertainty is out of the way. However, on a medium-term basis, the equity market reaction is expected to be more muted under a divided congress as corporate taxes are likely to remain static as a compromise.

The bigger risk we are seeing in markets is the concentration of positioning in certain markets and strategies. This most recently came to a head in early August – with a spike in volatility more usually seen in more distressed environments. Although we think underlying macro fundamentals are healthy, this market environment means macro events are magnified and the ability to be dynamic is important for portfolio construction. We are now seeing the same ‘overexuberance’ in bond pricing that was present in some parts of the equity market earlier in the summer.

Pro-cyclical bias

For the reasons above, we retain a pro-cyclical bias in the multi-asset portfolios at Cardano due to this positive growth, moderate inflation and supportive monetary policy regime. However, prior to the summer volatility – we reduced our equity exposure in July and retained some defensive option positioning – a strategy that allows us to add exposure on weakness. We are aware that there are many risks to our base case and so we are keeping our portfolios positioned for further equity market appreciation, whilst helping to manage downside risks.

Whilst traditional diversification in bonds has worked well in this recent period of volatility – we think the positive correlation between equities and bonds could resurface and we retain exposure to option protection, gold and defensive currencies in our portfolios.