Since the US Fed started raising rates in 2022 to tackle inflation, the US economy has demonstrated remarkable resilience. This resilience can be attributed to several factors:
- Consumers have benefited from tight labour markets and amassed significant cash reserves during the pandemic, reducing the necessity
for borrowing - Additionally, access to affordable long-term, fixed-rate loans has shielded them from the impact of higher rates
- Government cash transfers bolstered household savings, while both public and private investment received support from industrial policies, sustaining demand despite inflationary pressures
Current data suggests that the strength of these tailwinds is reducing, but not ready to go away fully (for instance, the 2025 Budget announced by US President Biden indicates that the US fiscal deficit will persist at elevated levels). Considering all factors, the US economy is on track to full-year 2024 GDP growth around the 1% range.
During recent Federal Open Market Committee (FOMC) meeting, the US Federal Reserve (Fed) maintained interest rates at steady levels and adopted a cautious stance, prioritising a ‘wait-and-see’ approach until there is clearer visibility on inflation trends. After months of speculation about earlier rate cuts, market expectations have shifted towards the long-held view that the Fed will err on the side of caution, preferring to wait rather than act prematurely.
In contrast, based on Q4 GDP data, the UK economy experienced a recession in the latter half of 2023. Looking ahead to 2024, UK growth is expected to remain below trend due to contractionary monetary and fiscal policies.
The Bank of England (BoE) maintained its Bank Rate at 5.25% during its fourth consecutive meeting on February 1st, countering market expectations for an interest rate cut as early as June. In our baseline scenario, we anticipate the BoE to begin cutting rates in the summer.
Inflation trending down, but not as quickly as expected
PCE (personal consumption expenditure price index) core inflation (the Fed’s favoured inflation measure) keeps moderating and is still far from the 2% target. This moderation underscores the complexity of inflation dynamics and explains why the Fed is being forced to wait for longer.
Progress from here is likely to be slower and require some degree of loosening in labour markets.
In UK and Europe, inflation dynamics are clearer and core inflation trends are pointing to a more marked and quicker conversion to desired target levels.
Central Banks Will Ease This Year, But Long-Term Rates Will Be Higher
All factors considered, interest rates will fall back from their highs in 2024, but stabilise at a higher level than we saw after the 2008 Global Financial Crisis in the coming years.
The real equilibrium interest rate (theoretical interest rate level at which monetary policy would neither stimulate nor constrain an economy) has risen for two reasons:
- Population is older on average (so accumulated savings are spent and working-age population shrinks)
- Higher structural government deficits
Less people saving + More people borrowing = higher rates
A Good Year Ahead for Bonds
Equities have enjoyed a solid start of 2024.
In terms of sectors, our preference is for high-quality, less cyclical stocks: a less robust economic environment will continue to work in their favour.
Looking ahead, equity performance will be reliant on whether economies revert to disinflation and near-zero interest rates (as observed post 2008 Great Financial Crisis) – or if they trend towards a pre-2008 era of stronger inflation and higher real rates.
Fixed income investors weathered periods of heightened volatility and negative price fluctuations in 2022 and parts of 2023, driven by central banks aggressively hiking interest rates.
Higher coupon yields, subdued nominal GDP growth, and a gradual shift in central bank monetary policy towards moderate easing should help bonds yield above-average returns in 2024.
To read the full AndPapers Q2 2024 click here.
