Stock markets globally rebounded sharply after a month of deep declines. On the one hand, earnings remain robust yet on the other macro headwinds threaten future earnings growth. In the shorter term, the US mid terms loom. The US goes to the polls tomorrow with the Democrats favoured to take the House and the Republicans the Senate. Any kind of Democrat toehold is likely to derail business friendly Republican policies which is causing some concern in the markets. Away from politics we note that US economic sentiment remains strong while European and Asian sentiment is losing some steam. Even so, we see some cracks developing in the US picture with the Manufacturing ISM declining more sharply than expected. The services number will be out today, and will be closely watched. The labour market continues its strong run and for the first time since the crisis 10 years ago, average hourly earnings grew at over 3% YOY.

Altogether, the global picture is one of a natural cyclical slowdown with the US prolonging its cycle at the expense of a weaker future fiscal position. Recession risks remain low but inflation risks are rising. This suggests an investment strategy which is sensitive to valuations (in both equities and credit) and increasingly cautious on duration.

We also see the flattening of the US term structure as mostly done and expect the recent steepening to continue as i) inflation expectations rise, ii) the Fed’s normalization reverses the demand imbalance for longer dated bonds, and iii) the risk rises that Treasury extends the duration of its issuance to fund the rising deficit.