"U.S. economic growth + Federal Reserve rate cuts = risk assets 'keep rising'?"
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The feast for risk assets may be far from over.
According to Chase Wind Trading Desk, HSBC’s September 22 research report “Up, Up, and Up Again” pointed out that signs of re-acceleration in U.S. economic data combined with Fed rate cuts constitute a “powerful catalyst” that will continue to push risk assets higher.
All types of asset prices are generally rising. We believe the real show has yet to come.
HSBC’s chief multi-asset strategist Max Kettner and his team analyzed that although there are market disagreements about the outlook for the U.S. economy and risks such as a weakening labor market and rising default rates, a series of indicators show the economy is regaining momentum. Meanwhile, the Fed’s dovish tilt has injected key liquidity expectations into the market. The S&P 500 index has hit a record high, while spreads in emerging markets and high-yield bonds have narrowed to cyclical lows.
The report emphasizes that the current U.S. “K-shaped recovery” not only poses no risk but actually strengthens its bullish view. On the one hand, rising wealth among high-income groups and healthy real wage levels support overall consumption and economic data; on the other hand, issues such as inflation pressure, wage slowdown, and rising default rates among low-income groups have become the key reasons for Fed rate cuts. This “high growth + loose monetary policy” combination provides a “Goldilocks” environment for risk assets.
Signals of U.S. Economic Recovery
The report lists a number of evidences supporting the judgment of renewed acceleration in the U.S. economy.
From a top-down macro data perspective, both U.S. weekly retail sales and composite growth indicators have improved since late June. Even labor market data, such as private sector overtime hours, are starting to show some early-cycle characteristics.
At the bottom-up micro level, the signals are even clearer. The report shows that earnings expectations for major stock indices have been sharply revised up in the past three months, a magnitude usually seen only in the early stages of an economic cycle. Meanwhile, U.S. listed companies themselves are also net raising their performance guidance.
In addition, capital market activities are warming up, and U.S. M&A and IPO markets are recovering. The report emphasizes that all these improvements are happening against the backdrop of a global increase in broad money supply.
Rate Cut Catalyst: Low-Income Households Facing Multiple Pressures
It’s not hard to paint a bleak growth picture: a weaker U.S. labor market, rising default rates, tariffs, and rising inflation in some parts of the world. But the report says, “Especially the ongoing K-shaped U.S. economic recovery, in our view, is not a risk but actually makes us more optimistic.”
The report explains that the reason the Fed is inclined to cut rates even as economic data appears to recover is that the weaker parts of the economy are struggling. Data shows low-income households are facing multiple pressures:
- Inflation Pressure: Inflation in “non-discretionary” items such as food, beverages, and housing far exceeds the overall CPI.
Low-income households spend a larger portion of their income. Tariffs may put additional upward pressure on food and other consumer goods. This could hit low-income households even harder.
- Wage Slowdown: Wage growth for the low-income and low-skilled groups has slowed much faster than for high-income and high-skilled groups.
Not only are prices for such consumer goods rising more quickly, but wage growth for low-income consumers and low-skilled groups has also started to slow more rapidly, while wage growth for high-income and high-skilled groups remains relatively healthy.
- Rising Defaults: Credit card and auto loan default rates have risen significantly since 2021.
It must be acknowledged that the overall level of credit defaults has not reached an excessively worrying stage.
It is exactly the plight of this part of the economy that provides sufficient reason for the Fed’s rate cuts.
Risks are Manageable, High-Income Households Support Consumption
While acknowledging the risks, the bank believes these problems are unlikely to trigger a full-blown recession. First, while credit card and car loan default rates are rising, their absolute levels haven’t reached an “excessively worrying level.”
Second, and most critically, high-income households are in good overall condition and are the group with the strongest consumption demand.
As the top 10% of income earners contribute about 50% of total consumption, their strong spending is enough to support the overall macro data, which is what market participants are most concerned about. Therefore, although the pressure on low-income groups is real, its drag on the overall economy is relatively limited.
Currently, consummer demand is strongest among high-income households, which should come as no surprise. Given they drive the vast majority of overall consumption, they also drive the headline growth data that market participants are most concerned about.
The report concludes:
While there is some pressure on low-income households, it might not be bad enough to trigger an economic downturn: 1) Their contribution to total consumption is too low (e.g., the top 10% income households drive about 50% of consumption); 2) Although a large part of household assets are held by high-income families, low-income families have actually experienced the highest proportion of growth since 2022. Consumption credit among low-income families has even declined since then.
Risk Assets Up, up & up more
Based on the above analysis, the report believes that the current environment supports holding more risk assets, and is optimistic about the outperformance potential of cyclical sectors in the stock market, while financial stocks are also favored due to the interest rate environment.
Due to lingering concerns about the U.S. dollar’s reserve currency status and debt sustainability, the upside potential for the dollar is limited, which in turn is beneficial to emerging markets. Therefore, the report maintains an “overweight” rating on emerging market stocks and local currency bonds.
Conversely, the bank maintains an “underweight” stance toward U.S. Treasuries, UK Gilts, and Japanese government bonds in its tactical asset allocation. The report concludes that U.S. Treasury yields still need to rise a lot before reaching a “danger zone” that would hurt risk asset valuations, which means that for the foreseeable future, bonds still look less attractive relative to stocks.
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