US soft landing expected: Will interest rate cuts further stimulate the market rally?
The stock market outlook remains attractive, with US technology, emerging markets and Japanese stocks showing promise
MARKETS previously worried that a slowdown in US economic activities – in particular, from the tariff war – could trigger a recession. However, the US economy now appears to be on track for a “soft landing”, that is, slowing growth but not a recession.
The US non-farm payroll data in August was disappointing, with only 38,000 new jobs added, far below market expectations. Furthermore, the US Bureau of Labor Statistics recently revised its data significantly, revealing that actual job creation from April 2024 to March 2025 was more than 900,000 fewer than originally reported, reflecting pre-existing labour market fatigue.
More notably, the increase in jobs was concentrated in the healthcare and social-assistance sectors, which account for only 17 per cent of the total employment market. Other sectors generally experienced contraction, suggesting emerging structural imbalances in employment.
Economic rebound: AI investment becomes the new driver
Despite this, US gross domestic product performance remained positive. Seasonally adjusted annual economic growth rebounded from -0.6 per cent in the first quarter to 3.8 per cent in the second quarter. Personal consumption expenditures remained resilient. While the market initially worried that tariffs would drag down consumption, the consumer market actually exceeded expectations.
More importantly, business investment in artificial intelligence-related technologies is growing rapidly, with spending on software and information processing equipment becoming a new engine of the economy. While US manufacturing investment has yet to fully recover, companies are beginning to reposition their operations to avoid import tariffs, potentially leading to a return of more production to the US market.
If tariffs further push up prices, the consumer market could yet come under renewed pressure.
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Interest rate cuts are reasonable, but inflation risks remain
In response to weak employment data and declining inflation, the US Federal Reserve announced a 25-basis-point interest rate cut in mid-September, with market expectations that two more cuts will come by the end of the year.
Fed chair Jerome Powell stated that the impact of tariffs on inflation should be one-off, but warned that businesses may pass the costs on to consumers. In fact, inflation in core services – particularly medical care and transportation – continues to rise, which warrants concerns.
The Fed’s independence is also a key market concern. If the Fed’s policies are to align with US President Donald Trump’s wishes, interest rates could fall further, while inflation and term premiums could rise. The recent widening of the yield spread between two-year and 30-year Treasury bonds reflects market concerns.
Despite high valuations, US stocks have strong earnings momentum
Yet despite slowing economic growth, US stocks continued to deliver strong earnings, surprising the market. Notably, earnings growth for 2025 for the Nasdaq 100 is forecast to reach 24 per cent, while the Russell 2000 small-cap index reaches 13 per cent. This outperforms the 8 per cent growth for the US Russell 1000 Value Index and the -1 per cent growth for European stocks, which were hit harder by tariffs.
Some investors are concerned about the high valuations of US stocks and are turning to European markets. Admittedly, the S&P 500’s forward price-to-earnings (PE) ratio is 22.5 times, one-and-a-half standard deviations higher than the historical average, but growth momentum remains strong.
“The latest worry for investors is the US government shutdown, but we do not anticipate this will have a sustained impact on risk assets.”
The latest worry for investors is the US government shutdown, but we do not anticipate this will have a sustained impact on risk assets. Any sell-off could be seen as a buying opportunity. In contrast, the MSCI Europe Index is only 14.5 times, an average level, but the earnings outlook is relatively weak. Investors need to make a trade-off between valuation and growth potential.
Technology stocks, emerging markets are promising
With continued signs of a soft landing, the stock market outlook remains attractive, and US technology, emerging markets and Japanese stocks are particularly promising.
In the bond market, as the US shifts towards a dovish stance, the European central bank has turned slightly hawkish on the back of Europe’s worsening fiscal budgetary challenges, giving US Treasuries a relative advantage. However, we believe euro high-yield bonds remain attractive due to their carry, and investors can manage risk by focusing on shorter duration bonds.
Last but not least, gold is once again playing its safe-haven role. The foreign-exchange market is less pessimistic about the outlook for the US dollar. The Australian dollar and some emerging market currencies, regarded as commodity currencies, are also expected to benefit. The writer is chief market strategist at BNP Paribas Asset Management
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