Weekly Investment Update (12/08/2023)

This Week’s Views and Positioning

At first glance, the jobs data may indicate a hawkish surprise that would contrast with recent dovish Fed comments about the future path of interest rates. Outside of perhaps pushing back expectations for rate cuts, we do not believe that to be the case. The 10-year Treasury yield increased 10 basis points (bps) to 4.23% on the news but remained 5bps below levels seen earlier in the week. Stocks also rose modestly, reflecting low expectations of a significant repricing of future monetary policy. In related data, the University of Michigan index of consumer sentiment increased well above expectations to 69.4 versus the prior reading of 61.3. This is the highest reading since August, reflecting easing price pressures amid a strong labor market.

Incoming economic data continues to strike the right balance. We see enough evidence to support the notion of slowing growth and inflation but very little that would indicate a recession. As long as this balance is maintained, stocks should be well supported. As a result, we maintain a moderate overweight to equites.

Labor Market Data  Allows the Federal Reserve to Hold Rates Steady

What is happening: Labor market data was mixed this week with the November employment report coming in stronger than expected while the Jobs Openings and Labor Turnover Survey (JOLTS) showed a softening in labor demand. Nonfarm payrolls rose 199k in November, higher than consensus expectations of 185k, primarily driven by job gains in the healthcare, government, and leisure and hospitality sectors. Additionally, the unemployment rate declined to 3.7% in November from 3.9% in October, and the participation rate rose from 62.7% to 62.8%. Average hourly earnings rose by 0.4% month over month, which kept the year-over-year reading at 4.0%. However, in the JOLTS survey, job openings declined by more than expected, falling to 8.7 million in October from 9.4 million in September.

Why it matters: The Federal Reserve is likely to cut interest rates next year, though the stronger than expected payrolls number and lower unemployment rate modestly pushed back market expectations for earlier interest rate cuts in 2024. As higher interest rates continue to permeate the economy, we expect labor demand to soften and continue its downward trend. The 199k payroll number is below the average monthly gain of 240k over the prior 12 months, and the number of job openings is well below its peak of 12 million openings in March 2022. Softening labor demand trends should, consequently, soften services inflation excluding shelter, given its correlation to wage growth, and allow the Federal Reserve to cut interest rates in 2024. The combination of slower economic growth and cooling inflationary pressures should push yields lower in the year ahead, and Bessemer’s fixed income portfolio managers have favored positioning that is longer in duration relative to portfolio benchmarks.

Moody’s Issued Negative Outlook for Chinese Sovereign Credit

What is happening: On Tuesday, ratings agency Moody’s changed its outlook on China’s credit rating from stable to negative. It’s important to note that Moody’s didn’t downgrade China’s credit rating, which remains at A1. This is similar to Moody’s revising down its outlook on the U.S. credit rating in November without downgrading its Aaa rating. The main reasons for Moody’s negative outlook on China are the central government’s increasing willingness to bail out struggling local governments, the persistent property sector downturn, and lower than expected economic growth over the medium term. Many local governments in China rely on the sale of land use rights as their main source of income, and the housing sector downturn has significantly decreased demand for new developer rights. Consequently, some local governments have run into serious cash flow and debt repayment issues that require capital injections from the central government. The central government transferred 1.6 trillion RMB to local governments in 2022 and recently announced the issuance of another trillion RMB of bonds to help with disaster relief and budget shortfalls. In addition, an increasing number of state-owned enterprises (SOEs), which are usually run less efficiently than private companies, have debt repayment problems and could need government assistance in the near future.

Why it matters: There has been some concern over the U.S. dollar’s global reserve currency status due to increasing national debt and political gridlock in Congress. Moody’s negative revision of China’s credit rating outlook highlights China’s economic vulnerabilities and shows that government debt problems are not limited to the U.S. This is another reason why it’s very unlikely for a different currency, such as the RMB, to dislodge the dollar’s dominant status in the foreseeable future. Moreover, China’s A1 credit rating is four grades below the U.S.’s Aaa rating, and by many measures, China is more levered compared to the U.S. While China’s central government has relatively low debt, the country’s overall macro leverage ratio, which aggregates central government, local government, household, and corporate debt, is higher than that of the U.S. China’s debt situation is also likely to get worse as economic growth slows, the working population shrinks, and local government financial stress increases. Bessemer’s portfolios currently have an overall underweight position in Chinese equities, and the investment team will continue to closely monitor these developments.