Friday Investors’ Club: positioning in credit for 2024 (9:41)

Last year’s sharp drop in rates may spark some near-term volatility, argues CIO’s Fred Mellors, but ultimately yields are heading lower, and we continue to recommend high quality bonds.

Thought of the day

Investors are bracing for the first high-profile economic data release of 2024-the US employment report for December. Evidence that the US labor market is cooling gradually will be crucial to maintaining optimism that the US economy is heading toward a soft landing. This will be a delicate balance. Overly strong jobs data could raise concerns that the Federal Reserve may become unwilling to cut rates as much as expected in 2024, while overly weak data would raise concerns that the US could be headed into recession.

So far this year, second-tier data releases on the labor market have been slightly too strong for comfort. The ADP survey for December suggested that a net 164,000 jobs were created in the private sector over the month, up from 101,000 in November and above the consensus expectation for 130,000. Added to this, the number of Americans filing new claims for jobless benefits in the last week of 2023 fell to a two-month low. Finally, the number of layoffs in December was down 20% versus the prior year, according to outplacement firm Challenger, Gray & Christmas.

Investors will therefore be hoping for renewed signs of moderating labor demand in today’s December jobs report. We have some concerns over the diminishing reliability of the report, since the share of companies responding to the survey has fallen from about 60% prior to the pandemic to just over 40% at present. But the release remains a key metric for markets, with investors likely to focus on three key elements of the report:

Job creation for the month is expected to slow, but not too abruptly. The consensus forecast, based on a Reuters survey, is that the US economy generated a net 170,000 jobs in the last month of the year, down from 199,000 in November. This would also be a marked decline from the 336,000 payrolls added as recently as September. An outcome close to the consensus expectation could contribute to confidence that demand for workers is moderating gradually.

The unemployment rate looks set to edge higher, while remaining close to multi-decade lows. The consensus forecast is for the jobless rate to rise to 3.8% from 3.7%. Again, this would be in line with our expectation for a soft landing. A moderate rise in the jobless rate would likely contribute to more cautious levels of spending by US consumers in 2024. But we don’t expect an increased fear of unemployment to cause a sharp rise in rainy-day savings and correspondingly sharp reduction in household consumption. Despite the recent increase, the jobless rate is still not far from the 3.4% hit earlier in 2023, which matched the lowest level since 1969.

The growth in earnings is forecast to slow, but only slightly. The consensus forecast is for average earnings to rise by 0.3% in December, down from 0.4%. It is worth noting that this metric is not the best measure of changes in wages, since it is now adjusted for the mix of employment. So, in December an increase in the hiring of lower-paid seasonal jobs could contribute to lower earnings growth. However, slower earnings growth could help reassure investors that rapid wage growth is unlikely to halt the recent moderation in inflation.

So, we believe that labor market data will continue to point to a soft economic landing, allowing the Federal Reserve to cut rates in 2024. Against a backdrop of slowing growth, we see the greatest potential for gains in quality bonds.