Worried about signs of a slowdown in the United States, the US market fell by around 6% in three sessions. Weak leading indicators, particularly in the manufacturing sector, and the slowdown in private-sector employment growth rekindled fears of a hard landing for the US economy.

Another sign of market nervousness over the summer was the sharp correction on the Japanese stock market, which lost 20% in yen terms in just three sessions at the start of August. Going against the grain of the major central banks in the developed world, Japanese monetary authorities surprised markets by raising key interest rates for the second time at the end of July. This unexpected rate hike led to a sharp rebound in the yen and took many investors in carry trades by surprise. In recent years, these operations have involved borrowing heavily in yen at very low rates in order to invest in much higher-yielding assets, particularly in dollars. The tightening of Japanese monetary policy has sharply reduced the return on this type of operation, forcing a large-scale unwinding of these positions.

Indexes at all-time highs

Market volatility soon subsided, however, with indices climbing back to new highs, buoyed in particular by accommodative rhetoric from the US monetary authorities and reassuring economic statistics on consumer spending, the driving force behind the US economy.

Pre-announced at the end of August by Jerome Powell, chairman of the US Federal Reserve, the first rate cut was implemented in mid-September. Confident about the future path of inflation, the monetary authorities opted for a 0.5% cut, a major move. They emphasised the resilience of economic growth, but considered that monetary policy should be made less restrictive in order to prevent the labour market from deteriorating too much.

As the savings reserves built up by households during the pandemic period have been fully used up, growth in purchasing power now depends on the dynamism of the labour market. A sharp slowdown in the labour market therefore poses a major threat to the US economy. Monetary easing is set to continue, albeit at a slower pace: the members of the governing council are forecasting a further 0.5% easing this year, 1% in 2025 and 0.5% in 2026, with a final rate of close to 3%.

Sectoral rotation

Equity markets reacted positively to these announcements. However, it is worth noting the significant sector rotation seen in recent months. Cyclical sectors and industries have generally underperformed defensive sectors, the latter benefiting in particular from a sharp fall in interest rates across all maturities. By way of illustration, the luxury goods and automotive industries in Europe have suffered particularly badly, impacted by sluggish Chinese and European demand. The technology sector has also stalled, particularly semiconductors, following questions about the sustainability of earnings growth.

Although the summer months were marked by an upsurge in volatility, the equity markets very quickly erased their losses and reached new record highs. Tight valuations--rising share prices have not been matched by rising earnings expectations--and risks to the global economy and corporate earnings do, however, call for greater investment selectivity.

Damien Petit is head of private banking at Banque de Luxembourg.

This article was originally published in .