18 November 2021
Is US exceptionalism returning?
Following a big upside surprise in the US consumer price index (CPI) and strong economic momentum, we analyse if the US could be poised for a return to exceptionalism.
Strong data releases suggest the US economy is firing on all cylinders. Inflation pressures broadened in November following a strong CPI print that beat market expectations. Core goods once again drove the increase in inflation, as used cars and shelter prices rose, while the potential for increases in airline fares present an upside risk for the next release. A similar theme can be seen in US consumption, which is being driven by demand for non-durable goods. Further recent strong US data included retail sales, which rose far more than expected, and the Empire manufacturing index, which remains at elevated levels. In addition, pressure from employment, in the form of an increasing quits rate, applies yet another squeeze on an already tight labour market, along with rising wage pressures. Energy pricing provides further support for the US economy, and in particular for the US dollar vs. the euro. The rapid increase in US liquefied natural gas exports at elevated prices over 2021 encourages further US dollar appreciation. The eurozone, as a net energy importer, has seen its trade balance deteriorate over the past few months, in large part due to increases in energy prices.
The Federal Reserve (Fed) is still priced to hike rates multiple times during the latter part of 2022 after its quantitative tightening programme has finished. In contrast, we expect the European Central Bank (ECB) to be more dovish on rates by committing to purchase bonds until at least December 2022, and thereby removing market expectations for hikes next year. Further evidence of US exceptionalism can be found in the currency markets, where the euro has steadily depreciated vs. the US dollar from the end of May 2021, to the lowest level since July 2020, spurred by yield divergence. There may be room for further depreciation based on swap rate spreads. US and European investment grade credit spreads remain tight, at 89 basis points (bps) and 93bps respectively, with both spreads widening slightly this month. As we move down in credit quality, however, a greater divergence appears regionally. US high yield spreads, at 310bps, are currently near year-to-date tights, while European high yield spreads, at 330bps, are unusually significantly wider than their average over 2021. Emerging market high yield presents a similar situation, where spreads have widened vs. US high yield.
The euro makes new year-to-date lows vs. the US dollar, spurred by yield divergence
Investors currently hold short US duration positions in combination with long US dollar positions, according to J.P. Morgan Asset Management proprietary surveys. A similar short European duration rates position is also held; however, this is in contrast to the deteriorating momentum in investor positioning in euros since June 2021. New issuance in European and US credit markets is expected to be high over the next week, before quietening down in December. In quieter conditions, investors should remain vigilant of both risks and opportunities in less liquid markets.
What does this mean for fixed income investors?
Expectations of widening policy rates are supportive of a stronger US dollar; however, US dollar appreciation will likely be restrained by activity in China, which is supporting the euro by rebalancing its currency reserves. Within fixed income markets, we are looking to capitalise on the emerging US exceptionalism theme by remaining short US duration in rates markets, while seeking opportunities in risk assets, with an eye on volatility as we enter the less liquid, last stretch of 2021. In particular, emerging market high yield and European high yield are appealing from a valuation perspective, although a question lingers over when the market may recognise the attractiveness of these sectors.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum