Bond yields are drifting lower again, and JP Morgan thinks that could help stabilise equity markets after a summer of leadership churn and rising uncertainty.
The US 10-year yield, now just below 4.1%, is back at year-to-date lows once you strip out the brief panic around June’s "Liberation Day" risk-off move.
The bank expects this trend to continue, supported by signs of a cooling US labour market.
Recent payroll data has come in soft, jobless claims are edging up, and the labour market differential, tracking the gap between those saying jobs are plentiful versus hard to get, is narrowing.
That said, the fixed income outlook is not all one-way traffic. JP Morgan concedes that term premia could still rise and that the yield curve is likely to steepen over time. The long-duration trade, in other words, may not work equally across the curve.
Earlier in the summer, the bank highlighted a sharp divergence between the performance of cyclical stocks and defensive sectors relative to bond yields, in both the US and Europe.
That gap has now mostly closed in Europe, and cyclicals have lost momentum in the US as well. JP Morgan sees this lower-beta environment as a positive sign for overall market resilience, though it reckons some adjustment is still to come if yields keep heading lower.
Regionally, UK equities continue to receive cautious feedback from clients, particularly given the fiscal backdrop. The bank remains neutral overall but points out that UK small caps are now trading near three-year lows.
This seems at odds with the composite purchasing managers’ index, which has risen by five points in recent months. On that basis, further underperformance from small caps looks unwarranted.
Eurozone equities are still viewed with some scepticism. The bank has been cautious on the Euro Stoxx 50 since March, citing over-optimism, and remains cautious on the region relative to the US.
France has been in the headlines, but JP Morgan notes it has already underperformed significantly this year, and political risk may now be largely priced in.
In style terms, the bank has flipped its previous view and now prefers value, small-caps and emerging markets after years of favouring growth, large-caps and developed markets.