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The economy and markets
Key points to know
How will the U.S. land? And when?
Headline U.S. economic performance has been solid so far this year. Previous areas of weakness, such as housing, have begun to rebound. Meanwhile, consumer spending has defied gravity, boosted by continued job growth and steady wage gains. Real consumption growth is running at an annualized rate above 4%, an acceleration from last year. But some cracks are emerging. Banks have substantially tightened lending conditions and delinquency rates are ticking up. Surveys point to contraction in manufacturing, while leading indicators within the labor market (e.g., overtime hours) have weakened. We continue to believe the risk of a (probably mild) recession is elevated over the next several quarters, though the timing keeps getting pushed further out.
Concerns about the global economy are growing
Even as U.S. growth has powered ahead, global momentum has faltered. China has disappointed considerably. Expected growth near 6% for this year has been revised down to 5% or less. The post-Covid reopening lacked the expected gusto, and business confidence is faltering. The construction sector, historically a key growth engine, has sputtered. Property sales are now running -20% year-over-year and -50% compared to the 2019 to 2021 average. At the same time, data from Europe are also softening. Business surveys have weakened to their lowest levels since 2020, and exports are contracting. All in all, the global economic landscape looks much less favorable than at any point post-Covid.
We continue to believe the risk of a (probably mild) recession is elevated over the next several quarters.
Compounding inflation problems persist
Exacerbating the difficulty for the European economy, inflation remains stubbornly sticky at elevated levels. Core inflation is +5.3% year-over-year in the eurozone, only marginally lower than its peak earlier this year. In the U.S., incoming data have been substantially more favorable, with annualized core inflation at +4.7%, down almost two percentage points from its peak. That’s still too high for the U.S. Federal Reserve’s comfort. The bottom line: Central bankers can’t relax just yet.
Where to steer the ship
Markets are essentially pricing in no additional U.S. rate hikes, plus cuts of more than 100 basis points in 2024. The yield curves in Europe and other developed markets look similar. Our base case expectation is that the Fed doesn’t enact rate cuts until the second half of 2024. Relatively high cash yields are tempting some investors to maintain elevated cash allocations. But they’ll also need to stay focused on the risks — especially the risk of forgone gains. Historically, long-term yields peak just as the Fed completes a hiking cycle, and tend to rally thereafter (Figure 2). We believe this presents an argument for investors to modestly extend duration rather than overallocate to cash.
All market and economic data from Bloomberg, FactSet and Morningstar.
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