Moderate growth rubs up against overblown hopes of rate cuts

Read the market analysis and fund positioning

Macroeconomic house view – December 2023

Global

Global economic activity remains on a downtrend. Recent economic surveys continue to signal moderate global growth in 2024. The monetary tightening of the past few years is affecting Western economies with the expected time lag. The gap between the manufacturing sector and the services sector is narrowing. While manufacturing is improving (but still contracting), the rate of expansion in the services sector is gradually slowing. The differences in regional growth remain substantial. While U.S. economic growth has slowed, the data are still solid and the chances of a soft landing in 2024 are increasing. This contrasts with a difficult situation in the Eurozone, where growth is slowing rapidly. The economic outlook for China, however, is improving thanks to strong political stimulus. The real estate sector will continue to impact on the country’s economy.

Inflation declined rapidly in the second half of 2023. However, it is definitely too soon to bank on a smooth disinflation course towards central banks’ 2% target. While there are no longer any pandemic-induced supply shocks, geopolitical tensions, protectionism and ongoing fiscal measures continue to exert inflationary pressure. Given the downtrend in prices, central banks were validated in adopting a cautious “wait-and-see” attitude in the past two quarters. It is now beyond all doubt that the key rates of the major Western central banks have reached a cyclical peak. However, considering that the inflation target has not yet been reached and given the not-unlikely possibility that the neutral interest rate level could be higher than pre-pandemic, we think the number of rate cuts expected in 2024 is excessive. Chinese monetary policy will remain expansionary, in step with fiscal stimulus. The BoJ is the only central bank that could tighten policy in 2024.

United States

After a very strong third quarter, the U.S. economy lost momentum in the final three months of the year. Even though the latest U.S. data signal weaker growth and falling inflation as a result of restrictive monetary policy, there are no signs of imminent recession. GDP growth for the fourth quarter of 2023 is still expected to come in at a healthy 2.3%. Labour market data may be mixed, but is not showing any signs of collapse. While the number of new jobs continued to decline, unemployment fell to a four-month low of 3.7%. Consumers are upbeat and continuing to drive economic expansion. Thanks to a relaxation in financial terms and solid personal incomes, retail sales rose at an encouraging pace.

The disinflationary trend continued, with headline inflation falling to 3.1% thanks to the reduction in energy prices. However, core inflation did not budge from 4% due to the ongoing price pressure in the services and rental sectors. Even though the slowdown in inflation is a welcome development, we doubt that inflation will come back down to the 2% target any time soon given the solid labor market, resilient consumer spending as well as expansionary fiscal policy due to 2024 being an election year. As expected, the Fed left policy unchanged in December but surprised markets with a dovish tone and even announced that it had started to consider cutting interest rates. In light of the U.S. presidential election later in 2024, we suspect that, when faced with a choice between combating inflation and avoiding recession, central bankers may have decided in favour of the latter. One thing we are sure about: Given current growth projections and the signalling of three rate cuts (which the market has increased to no fewer than six in 2024), inflation will definitely not fall to the 2% mark.

Eurozone

Eurozone growth remained disappointing in the fourth quarter despite a slight improvement in November. Private-sector economic activity contracted in December for the seventh consecutive month, raising the risk of a technical recession in the second half of the year. Weak global demand is impacting on the entire Eurozone, with industrial production having fallen to its lowest level since 2020. Germany is particularly badly affected, with a further fall-off in industrial orders and production. On the whole, the data point more towards economic stagnation than a slump. Growth will continue to decline and remain low in the first half of 2024. Unemployment is stabilising at 6.5% and consumer confidence is consolidating at a very low level. While retail sales figures and demand from abroad are flagging, there are tentative signs of an improvement in the manufacturing sector.

November saw price pressure fall sharply to 2.4% year on year, though in the services sector it remained high at a level of 4%. Core inflation also came down significantly year on year, from 4.2% to 3.6%. Considering that this is still well above the stated target and the PMIs are reading further rises in cost pressure and wage growth throughout the Eurozone, the process of disinflation is far from over. The ECB’s tightening cycle has come to an end. However, its president has indicated that – unlike the Fed – the ECB is not yet ready to talk rate cuts. Here too, the market’s estimates for rate cuts are much more aggressive at up to six increments. There is a lot at stake for European politicians: Cutting too early in an environment of sticky inflation and constant fiscal stimulus would be a mistake. But pursuing a restrictive policy for too long could lead to an even steeper economic downturn. The question will be how patient and dogged the ECB can be in the face of uncertainty and, possibly, a Fed that is no longer quite so restrictive. The fact is that the final mile in getting to the 2% inflation target will be the most complicated and could by all means entail further economic pain.

China

China’s economic recovery continued at a moderate pace in the fourth quarter, driven by domestic consumption. Exports rose slightly in November, while imports declined due to ongoing weakness in the real estate sector. However, the economic environment remains disinflationary: Both headline inflation and producer prices are in negative territory year on year (-0.5% and -3%). The credit situation improved last quarter thanks to large-scale government measures to boost credit growth.

At its December meeting, the Politburo pledged to “effectively enhance economic vitality... and continue to promote the effective improvement of quality and reasonable growth of the economy”. There is no doubt that fiscal policy will be the driving force behind economic growth in 2024; however, there are no signs of large-scale fiscal stimulus – only additional targeted measures. Monetary policy will provide flexible and effective but prudent support. The outlook for China is obviously a bit more constructive than in the past few months; even so, the upturn will remain gradual and the real estate sector will continue to experience problems, thus dampening economic prospects in 2024 as well.