A pleasant surprise for the US economy

The September employment report surprised with a much higher increase in non-farm payrolls, while at the same time, the unemployment rate fell to 4.1%. Unemployment fell despite a solid 150,000 increase in the labour force in September, which was more than offset by higher employment. 

The higher number of full-time jobs and the upward revision of past job gains contributed to the view that the US labour market remains very resilient. Upcoming revisions suggest that the true pace of job gains is lower, rebuffing both claims of an overheating and fears of severe worsening. The better-than-expected state of the US labour market will most likely dissuade the Federal Reserve (Fed) from taking another bold step in easing monetary policy by 50bps. We maintain our view that a swift rate reduction to a neutral level of 3%–4% is warranted and the best insurance against a downturn next year. 

At the same time, the probability of a further 50bps cut at the next Federal Open Market Committee meeting in November has fallen sharply and could only rise if the next employment report, due just six days before the meeting, were to be surprisingly negative. We are adjusting our path for rate cuts and expect a series of 25bps cuts to bring the Fed funds target range to 3.25%–3.5% in June 2025, which we view as a neutral stance.

Q3 earnings: The bar is set low this time around

The Q3 earnings season will kick off later this week. While the bar for companies seems to be lower compared to last quarter, the focus of investors will be on the outlook of the corporates. The consensus is currently expecting 4.2% of earnings growth for the S&P 500 for Q3 year-on-year, revised down from 8.1% over the past three months. The downward revision in earnings estimates is higher than the 10-year average of 3.3% and is concentrated mostly in the cyclical sectors, suggesting that analysts are increasingly worried about an economic slowdown.

Meanwhile, information technology has been the only sector to experience upside revisions in Q3 earnings estimates over the same time period. Together with healthcare, the sector is expected to report the highest Q3 earnings growth, while the oil & gas and materials sectors are projected to report the weakest. 

Oil: Engulfed in geopolitics and noise 

Oil prices are soaring as the conflict in the Middle East heats up. There are fears that the Israeli-Iranian stand-off could disrupt oil supplies. We leave it to the geopolitical experts to sketch out possible paths of military escalation. There are some signposts, however, that have been a solid guide since the outbreak of the Gaza war. Uncontrolled turmoil is in no one’s interest in the region. The United States maintains military superiority in the region and is fearful of a potential return of inflation, especially ahead of its presidential election.

Our observations from the oil market are as follows. First, geopolitics tends to be a temporary element, with oil prices rising and subsequently falling again within weeks and months. Second, sensitivity to the war in Gaza has so far decreased this year. Third, prices trading around USD 80 suggest that the market anticipates an escalation. 

What does this mean for investors?

The US is all about how the soft landing will proceed in the weeks and months ahead. On the upside, this means lower recession risks for the US, on the downside it means slower rate cuts by the Federal Reserve. We expect 10-year US Treasury yields to remain close to current levels at 3.85% in three months and 4% in 12 months. Growing optimism that the US economy will continue to expand at a moderate pace in 2025, will prevent 10-year US Treasury yields from following the Fed funds rate lower.

Given the above-average downward revisions in earnings ahead of the start of the season, we believe that the bar for companies to beat is comparatively lower than in Q2. As usual, the focus of investors will also be on the outlook. In particular, any updates on capital expenditures related to artificial intelligence, the outlook on China, and the latest state of the restocking cycle will be closely monitored.