J.P. Morgan: A stronger dollar, Energy OW and a high-for-long scenario coming
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J.P. Morgan strategists believe that the Fed will hold higher rates through next year’s third quarter, as said in their Monday global markets strategy report.
The 2024 and 2025 median dots were revised by the Fed to be 50 basis points higher due to a strong economy and continued inflation, still above target through 2026.
“In the current environment, the assumption is that having additional immaculate disinflation would allow rate cutting without having to have growth risk be the driver for the disinversion” of the yield curve, J.P. Morgan economists said in the report.
And the longer-term history of the yield curve inversion could show the potential for a bearish outcome.
J.P. Morgan strategists highlight three points:
The long period required for core inflation would come down after peaks, and company margins and profitability could create the risk of a worsening job market. Earnings per share downgrades could be imminent.
The lagged impact of a recession is coming. “It is difficult to have such a tightening of policy, via both rate hiking and balance sheet reduction, and not have a recession.”
It would be easier to produce a soft landing if the rate hike had stopped before the yield curve inverted, and data shows “we are well beyond that point in the current cycle,” according to J.P. Morgan global markets strategy.
J.P. Morgan strategists also said that price action in August and September confirmed their strategy of “staying defensive and trimming portfolio duration.” The brokerage added to cash because of a stronger dollar (DXY) outlook and held an Energy (XLE) overweight despite geopolitical developments and the high-for-long scenario, where bond yields could face headwinds but returns “should be still positive.”
For Equities, valuations and earnings would be at risk, they said.
What exactly drives the high-for-longer environment would also dictate if stocks’ yields came out higher than bonds.
“An AI-driven productivity shock, which has not yet materialized, would favor stocks, but a reversal of previous tailwinds that centers more on geopolitics could favor bonds and cash,” the economists said.
In addition, according to J.P. Morgan economists, each week the U.S. government stays in shutdown, annualized GDP growth reduces by 0.1%. The Congressional Budget Office estimated the five-week shutdown reduced real GDP by $11B or 0.3%, of which $3B was non-recoverable once spending resumed.
During the past five shutdowns (1995, 1996, 2013, and 2018–2019), Treasury yields fell ahead of the expiry of the government resolution and further as the shutdown began. This time, a government shutdown may drive yields higher, given the interest rate environment.