The Fall Shift: Market Optimism and the Soft Landing Debate

The turn of the calendar from August to September marks the start of Fall, school, and all things pumpkin spice. This year, it also brought about a shift in markets as pricing eschewed the recessionary fears of the summer and embraced a benign “soft landing” narrative.

Our interpretation of this move is that it primarily reflects optimism around inflation returning to target rather than an upbeat perspective on real activity. While macro data has been broadly supportive of this view over recent quarters, we believe that market pricing of this outturn is becoming stretched and investors are crowding into associated positions.

As such, we anticipate that asset prices will place incrementally more probability on outcomes in which inflation remains persistent and reflation unfolds rather than embedding even greater expectations of a soft landing.

A variety of traditional and alternative data underpin this view. We lay out an example of each below.

Not too hot, not too cold

While Goldilocks may have preferred porridge over pumpkin spice, macro investors’ assessment of the economy appears well aligned with her “not too hot, not too cold” thesis as we head into the Fall. Specifically, the current consensus narrative is solidly anchored on an outturn in which inflation cools and growth moderates while avoiding a recession.

As investors interpret macroeconomic developments and form views, it is important to be able to determine whether those views are already priced in markets and where dislocations may appear. We do this in a structured way through a framework we call “What’s Priced”.

The chart below shows our assessment of market pricing of the soft landing narrative across a multi-asset universe and helps to demonstrate the degree to which macro investors have coalesced around this expectation. Since its late April nadir, our soft landing pricing factor (which plots the returns to a range of assets that would perform well in this scenario) has moved approximately two standard deviations higher and is currently at its highest level in the last 20 years.

Soft Landing Pricing: Starting our descent?

Making a call on inflation

As noted above, market sentiment around inflation in recent months seems to reflect greater disinflationary optimism. A cross-check with alternative data confirms this hypothesis. One way we measure this is by machine reading transcripts from company conference calls and tracking the relative frequency of terms associated with concerns over inflation. The chart below shows that this metric has plummeted over recent months.

Company conference call transcripts show low concern over inflation

We use this tool as an additional indicator of what’s priced into markets - if everyone is talking about a topic, it’s likely already priced in! Looking at the evolution of this indicator over the course of 2024, we note that market participants’ conviction in disinflation was also high in January and February. However, price pressures subsequently reaccelerated and bond yields rose along with inflation between January and the end of April. We see potential for a similar swing in market attention heading into the final quarter of the year.

What does it mean for portfolios?

Based on our current insights, we are positioned for asset prices to embed a higher likelihood of nominal economic growth proceeding at an elevated pace rather than conforming to a soft landing. This means we are broadly overweight equities and underweight long-dated fixed income assets in multi-asset portfolios.