Soft landing in sight as US labor market cools

- Investors are optimistic but are they underestimating inflation risks? # # --------------------------------------------------------------- The key takeaways today: - A runway for a soft landing is in sight - The outlook for US corporate defaults - Global M&A volumes tick higher Was this newsletter forwarded to you? ([Sign up now.]( --------------------------------------------------------------- The US labor market continues to cool as a soft landing approaches Although most forecasters still predict a US recession in the next year, Jan Hatzius, chief economist and head of Goldman Sachs Research, says the runway for a soft landing is in sight. “US economic activity remains resilient, the labor market rebalancing is making progress, and the recent CPI and PCE data suggest that disinflation may now be running slightly ahead of schedule,” writes Hatzius in his [latest Global Views note](. Although the recent July employment report showed a weaker-than-expected nonfarm payroll gain of 187,000 as well as downward revisions to prior months, the unemployment rate edged back down to 3.5% as the rebound in labor force participation has slowed and the breakeven job growth rate shows signs of normalizing. Despite continued low unemployment, Goldman Sachs Research's jobs-workers gap — the difference between the total number of jobs (in other words, employment plus job openings) and the total number of workers — is trending down on the back of reduced job openings. Wage growth is also cooling. While average hourly earnings grew a faster-than-expected 0.4% in July, other wage indicators such as the Q2 ECI and the Atlanta Fed wage growth tracker measure came in on the softer side. GS Research's wage tracker has slowed from a peak of nearly 6% in 2022 to the 4.5 to 5% range now. --------------------------------------------------------------- Corporate credit concerns Higher US interest rates have spurred worries about rising levels of distressed debt or even a wave of defaults across major parts of the corporate credit market. The latest episode of [Goldman Sachs Exchanges]( breaks down the challenges around corporate credit that were the topic of Goldman Sachs Research's latest [Top of Mind report](. GS Research's Chief Credit Strategist Lotfi Karoui is generally optimistic about corporate America's credit outlook and believes healthy fundamentals should allow most companies to weather the more challenging borrowing environment. “The risk of a full-blown default cycle is still fairly low, at least if we're talking about the next 12 months,” he says. “I would characterize things as mean reversion without a severe deterioration.” Boaz Weinstein, founder and CIO of Saba Capital Management, doesn't share this optimism. He argues that credit spreads, which currently lie at the lower end of the post global financial crisis historical range, aren't sufficiently pricing in the present high level of macroeconomic uncertainty, and that corporate defaults will almost certainly rise from here. “You're seeing the effect of higher rates for longer,” he says. “If this continues, I really do think it's not prognostication anymore, it's almost certainty that the default rate's going to rise.” --------------------------------------------------------------- Investors turn optimistic on inflation... Investor sentiment turned markedly positive in the latest Marquee QuickPoll, which surveyed close to 700 institutional investors in early August. While participants surveyed say they expect key markets to be rangebound for the rest of the year, they may be underestimating key risks, says Goldman Sachs' Oscar Ostlund, global head of content strategy, market analytics and data science for Marquee in Global Banking & Markets. One of the biggest surprises is that 61% of those surveyed expect US core inflation will drop quickly to below 4% by year end. “While the data is overall confirming the soft-landing trade, the broad consensus for a rapid decline in inflation creates an inherent risk if or when inflation data beats the forecast,” Ostlund says. --------------------------------------------------------------- ...and increase their appetite for risk The Goldman Sachs Risk Appetite Indicator rose this summer to the highest level in about two years, as inflation moderated and economic growth was more resilient than some expected, helped by a resilient services sector. “If you look historically, inflation and growth usually go down together,” says Christian Mueller-Glissmann, head of asset allocation research within portfolio strategy at Goldman Sachs Research. “Yet you've had a huge amount of inflation normalization without the growth damage.” The second half of the year could be more challenging. Purchasing manager index (PMI) surveys suggest confidence in the global economy is weakening, even in services. While economists at Goldman Sachs Research expect the US to avoid a recession, that doesn't mean GDP growth will be robust. “The growth picture in the second half is not that exciting,” says Mueller-Glissmann. “I think you're dealing generally with growth being below trend in a lot of places.” On balance, he says the basic 60-40 portfolio — split between stocks (60%) and bonds (40%) — could make more sense again in the near term, even as that setup has challenges in the long run. He says the level of yields available in the bond market, coupled with cooling inflation, means bonds may be a better opportunity for portfolios than they were. However, there are still risks in the longer term: growth could stagnate, inflation could rise again, and in the meantime, longer-term bond yields have shown signs recently of climbing higher. A wildcard, Mueller-Glissmann points out, is an increase in productivity from artificial intelligence.[[Read the related article]( --------------------------------------------------------------- Global M&A volumes are ticking higher, driven by megadeals After a muted start to dealmaking in the first quarter, we are witnessing positive signs of increased momentum in M&A. Large-scale M&A returned in the second quarter with 10 announced deals larger than $10 billion, above recent averages. Corporate activity continued at a strong pace, and we have seen an encouraging uptick in activity and dialogue from financial sponsors. - Corporate separations, [already growing at a robust pace]( will be a significant driver of M&A activity, with management teams and boards focusing on strategic transformation, portfolio management, and shareholder value. - Take-privates are expected to remain a bright spot as financial sponsors look to deploy dry powder while utilizing larger equity checks and more creative financing structures. - After accelerating meaningfully in the second quarter, activism should continue at elevated levels as new funds adopt traditional activist tactics and larger, more established funds increasingly adopt private tactics. --------------------------------------------------------------- BlackRock's Rick Rieder on his career, the markets, and investing in the current environment Rick Rieder, chief investment officer of Global Fixed Income for BlackRock, and his team are responsible for managing roughly $2.4 trillion of assets. In the latest episode of [Goldman Sachs Exchanges: Great Investors]( Rieder shares his perspectives on investing, the markets and economies, and lessons learned over his career. Rick Rieder of BlackRock and Tony Pasquariello of Goldman Sachs On unconstrained investing. “The beauty about being unconstrained is you try and figure out where the big pockets of alpha are,” Rieder tells host Tony Pasquariello, global head of Hedge Fund Coverage within Goldman Sachs' Global Banking & Markets business. “And then how do you manage your portfolio to try and optimize return but manage the downside?” The importance of liquidity. “I've always found when I've invested in credit or equities or anything, I think there are only three things that matter for investing: leverage, liquidity, cash flow,” he says. “If your leverage is high but you've got plenty of liquidity and your cash flow is high, you can actually deal with it. You can't if your liquidity goes. It's over.” The strength of the US economy. “The US economy is 70% services. 70% consumption. That ends up being incredibly stable,” he says. “I just think the US economy is much more durable than people [think].” On his daily habit of waking up at 3:45 am. “I'm pretty energized. But I think there's a lot to do in life. And I have these signs all over my house that say, ‘Work hard, play hard, give back, reboot,'” he says. “Everybody's different, but I feel like, you know, there are so many cool things to do.” --------------------------------------------------------------- Briefings Brainteaser: Touring makes a comeback For many music artists, touring and live events make up most of their income. Which of these superstar artists generated most of their earnings from touring in 2018? A) Ed Sheeran B) Kenny Chesney C) Drake D) Bruce Springsteen E) Taylor Swift [Check the answer here.]( --------------------------------------------------------------- Goldman Sachs in the news [CNBC]( August 14 [The risk return is not looking as good for markets right now, says Goldman Sachs' Ashish Shah (5:38)]( [CNBC]( August 11 [China generative A.I.: Goldman Sachs says business-to-business side is the biggest revenue driver (3:40)]( [The Economic Times]( August 7 [IIMB's NSRCEL and Goldman Sachs 10,000 Women launch initiative to help women entrepreneurs raise capital]( --------------------------------------------------------------- --------------------------------------------------------------- Some of the images used in this newsletter are sourced via Getty Images. The data provided in this newsletter is for information purposes only and should not be construed as investment or tax advice nor as a recommendation to buy, sell, or hold any particular security. 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