2024: almost the best of all possible worlds… Given what we’ve been through!
Macro Point
GDP growth in 2023 is expected to exceed forecasts made a year ago, by 1 percentage point globally and 2 percentage points in the US, while core inflation has fallen from 6% in 2022 to 3% sequentially in economies that experienced a post-COVID price surge. Our central scenario is based on a soft landing for the global economy in 2024. Elections will be held in several countries next year. With the rise of populism and polarization, we should be in for some negative surprises. We believe we have good visibility in terms of inflation and therefore monetary policy for the first few months of the year. Central banks will remain vigilant and will be slow to plunge into a rate-cutting cycle. A soft landing for the US and global economies, combined with falling inflation, should be a favorable cocktail. If monetary policy continues to operate with long and variable lags, it would be premature to declare a total victory over inflation.
Core inflation (headline inflation excluding energy and food)
Sources : Bloomberg, Richelieu Group
We forecast several factors favorable to global growth in 2024, including strong growth in real household incomes, less pressure from monetary and fiscal tightening, and a recovery in manufacturing activity. While growth dynamics will remain heterogeneous between regions, inflation dynamics will be more homogeneous. Most countries are experiencing gradual disinflation due to the dissipation of the effects of supply shocks combined with tighter financial conditions. Liquidity conditions continue to diverge around the world: the USA and Europe are in a tightening phase, while Japan is moving in the opposite direction ; China continues to offer steady stimulus. GDP growth will continue to resist in 2024, but will remain rather sluggish and weaker than in 2023. We expect a U.S. recession in mid-2024, but a short and shallow one.
Estimated GDP growth
Sources : Bloomberg, Richelieu Group
The main factors pointing to sluggish global growth include higher unemployment, higher interest rates and less impetus from fiscal policy. Economic growth will be sustained by falling inflation, which is restoring growth in real disposable income and excess household savings, very tight labor markets which are unlikely to weaken abruptly, and which continue to generate solid, albeit slower, wage growth.
Central bank rates
Sources : Bloomberg, Richelieu Group
The disinflationary impetus provided by energy is fading fast and slowing for food prices. At the same time, wage pressures remain formidably high, making core disinflation difficult. Most of the major central banks in the developed world have probably completed their cycle of rate hikes, but there’s still a long way to go. According to our reference scenario of a strong global economy, rate cuts are unlikely to take place before the second half of 2024 (Q4 in the US, 2025 in the eurozone). In many emerging countries, central bank rates are already being cut. We expect central banks in the advanced economies to follow suit timidly, or even to remain sensitive to inflationary risks. Central banks will only act if there is a systemic risk. It’s up to us to detect the weak signals that would plunge us into a much more complex scenario.
US: Overheating finally moderating.
In 2024, the US economy is set to slow, with real GDP growth dropping from 2.5% to 1.2%. Inflation, though low, is expected to be between 2.5% and 3%, slightly above the Fed’s target. The unemployment rate, meanwhile, is set to rise to almost 4.5% by the end of the year, up from 3.4% in 2023.
Unemployment and employment rates in the US
Sources : Bloomberg, Richelieu Group
In our reference scenario, we expect a soft landing for the US economy. Positive growth, albeit below potential, is expected. Unlike in Europe, inflation has been particularly affected by resilient US consumer demand: economic moderation will have a disinflationary effect. Rent inflation (44% weighting) has slowed from over 16% in early 2022 to just 3% in September 2023. This growth dynamic, implying gradual disinflation and a slowdown in employment, should enable the Fed to envisage a 25 bps interest rate cut in the second half of the year, to a terminal rate of 3.5% in 2026. The Fed seems to be successfully navigating a soft landing where unemployment rises only marginally, while labor market tensions ease as demand for labor diminishes. The US economy surprised on the upside, exceeding initial forecasts of a recession with a soft landing. This change is attributable to the resilience of consumption, strong fiscal impetus and dynamic investment supported by favorable policies. This performance contrasts with the Eurozone and China, where consumer and business confidence is significantly lower. The drivers of consumption remain strong. The strength of US consumption is supported by a robust labor market and underpinned by solid growth in disposable income.
Wage growth in the US
Sources : Bloomberg, Groupe Richelieu
Note : Monthly salary growth is annualized.
Considerable excess savings, reduced by around 55%, also play a crucial role. Real net worth of household wealth increased by around 15% compared to pre-pandemic levels, thanks in part to massive mortgage refinancing and resilient property prices. Despite this resilience, the US economy is not without its challenges. Rising defaults and the resumption of student loan repayments, combined with higher real interest rates, point to a potential moderation in consumption. Nevertheless, we still expect robust consumption in the future. An alternative scenario could see the US economy suffer a hard landing, especially if overheating leads to a tightening of global financial conditions. This risk could materialize in the second half of 2024 or early 2025. Faced with this outlook, the Fed will play a key role in shaping the US economy. The gradual lowering of interest rates may be a sign of its commitment to supporting the economy while balancing inflation targets. Wage moderation is therefore set to continue. However, the Fed must remain alert to signs of economic overheating and be ready to adjust its policy if necessary. Accelerated quantitative tightening by the Fed and increased issuance of US government securities to cover the country’s large budget deficit will continue to limit credit flows. Given its desire to avoid the “stop and go” of the 70s, it will avoid showing that it is ready to suddenly reverse its monetary policy. We expect a long period of stability. The current rate level is, for us, compatible with its objectives.
FED rates, inflation and GDP in the 70s
Sources : Bloomberg, Groupe Richelieu
The US economy is heading towards 2024 with positive but moderate momentum. Many iconic US pieces of legislation, such as the bipartisan Infrastructure and Jobs Investment Act in 2021, the Inflation Reduction Act (IRA) and the CHIPS Act in 2022, are expected to boost productivity growth over several years, as government incentives encourage increased private sector investment. While challenges remain, notably in terms of inflation and unemployment, solid fundamentals such as strong consumption and investment should support growth. Disinflation is well underway, the United States enters 2024 in good shape.
Europe: Risk of stagflation but reassuring short-term signs
The good news is that inflation has peaked. The bad news is that, in the absence of fiscal stimulus on a scale comparable to that of the United States, the effects of the Ukraine energy shock and ECB interest rate hikes, the eurozone economy is on the brink of recession..
In 2024, the eurozone is likely to experience very moderate economic growth, with forecasts of stagnation at around 0.5%. Although this growth dynamic is considered anemic, it could pick up again slightly in 2025. We don’t think this will prompt the ECB to start cutting interest rates, in the hope of bringing inflation back below its target by 2025. Against a backdrop of stagflation, an economic slowdown accompanied by high inflation should enable European central banks to maintain their monetary policy in 2024 without major changes. Europe and the UK have been particularly hard hit by energy shocks, far more severely than the US. In the Eurozone, economic growth is forecast below market expectations, mainly due to the prolonged impact of the COVID-19 pandemic and energy shocks. The economic slowdown in Asia, particularly China, is having a negative impact on industrial production in Germany, and by extension, on economic growth in the euro zone. In addition, the tightening of global financial conditions, mainly due to US monetary policy, is putting further pressure on consumption and investment in Europe. Consumer confidence in Europe remains weak.
Consumer confidence
Sources : Bloomberg, Groupe Richelieu
Retail sales in the eurozone remain below the pre-pandemic trend, while sales in the US are well above it.
Retail sales in volume ( base 100 11/2015) and monthly variations
Sources : Bloomberg, Richelieu Group
On a positive note, the eurozone has not suffered any major new economic shocks this year, but the effects of the previous energy shock and monetary policy tightening are taking time to dissipate. The ECB will consider rate cuts from 2025 and wait until inflation is firmly anchored at or below 2%. We are witnessing a very moderate, almost stagnant growth scenario for the coming quarters, with a slight acceleration expected at the end of 2024. This forecast is based on a number of factors, including falling inflation, greater security of energy supply, the start of a rate-cutting cycle and moderate easing of fiscal policy. Interest rate transmission in the euro zone is faster than in the United StatesThis is because over 70% of corporate financing in the eurozone comes from banks (often at variable rates), compared with around 80% of US corporate financing from debt markets (mainly at fixed rates). Europe has made progress in reducing its dependence on Russian energy, but this process will take years. In terms of risks, the eurozone faces a number of challenges. Geopolitical tensions and oil price fluctuations remain significant risk factors. A persistent tightening of financial conditions due to the fallout from US policies is also a major risk. These factors could lead to a short-term recession, even though wages could continue to rise.
Extract from Isabel Schnabel’s presentation: Monetary policy in times of stubborn inflation
November 21, 2023
Source : European Central Bank(Click here)
The eurozone needs to strike a balance in its fiscal policy. A bad compromise on fiscal rules could result in a much tighter policy, leading to a deeper recession, increased disinflation and a more aggressive down cycle. In conclusion, although the eurozone faces a series of complex economic challenges, there are signs of a potential recovery. The The ECB will play a key role in this sequence. We expect it to continue, to a lesser extent, to adopt a restrictive stance even in the face of stagflation risks.
Source : European Central Bank(Click here)
Disinflation in the eurozone is not as advanced as in the US, but as the risk of recession increases and inflation slows, the ECB will remain inactive and allow time for measures already taken to take effect. Two positive surprises may be in store for Europe: on the one hand, China could rebound more strongly than expected, boosting global demand and growth in Europe ; on the other, oil prices could fall, reducing inflation and boosting growth.
China: The country is at a turning point in its growth model
We expected China’s reopening after COVID to boost global growth in 2023, but this optimism was quickly dashed. The root cause of the economic sluggishness is linked to problems in the real estate sector, which have affected property developers and municipal finances, and eventually contaminated the economy as a whole. In 2024, China should see GDP growth of 4.8%, slightly lower than the 5.3% recorded in 2023. This downward trend is set to continue in 2025, with growth estimated at 4.6%. However, it is essential to note that this moderate growth is supported by a gradual easing of monetary policy and targeted fiscal measures. To offset the slowdown in growth, the Chinese government is striving to stimulate public investment, particularly in the high-end manufacturing sector. This strategy is designed to mitigate the impact of stagnant investment in the real estate sector. Sentiment towards China has become too negative, given the range of recent stimulus measures and the sharp decline in new housing construction, already produced, and which could lead to stagnation in construction activity in 2024.
Direct investment in China
Source : FT
We expect the real estate market to stabilize in the first half of 2024, a crucial factor for investor confidence and economic stability. The loss of Chinese household net worth is not leading to a surge in consumption and confidence. However, China is not facing a US-style housing or financial crisis, as regulations on loan-to-value ratios are much stricter in China than the US rules in force between 2005 and 2008.
China faces a number of challenges, including an aging population, high youth unemployment and imbalances in the real estate market. The Chinese government, while acknowledging these problems, remains optimistic, viewing the current recession as temporary. In response, a package of policy measures was implemented, aimed at stabilizing property prices and stimulating domestic consumption. China is at a turning point in its growth model. Investment in real estate, which has long been an engine of growth, must give way to more productive investment, particularly in infrastructure. In addition, reforms are needed to improve labor mobility and adjust the retirement age, thus contributing to a more dynamic and sustainable economy. To avoid a scenario of prolonged stagnation similar to that in Japan, visit China’s political decision-makers must act decisively to boost confidence and reverse the growth trend.
Headline inflation in China and producer prices
Sources : Bloomberg , Groupe Richelieu
A delay in implementing appropriate policy measures could jeopardize China’s growth potential. It’s worth noting that China has become the leading exporter in critical strategic sectors such as electric vehicles (EVs) and solar and wind power, ensuring further growth for years to come.
Source : IEA(Click here)
With regard to inflation, we expect consumer prices (CPI) to rise towards the end of the first quarter of 2024, due to the gradual recovery in consumption. Producer price inflation (PPI) is also set to turn positive, reflecting the impact of the infrastructure stimulus. Finally, relations between the United States and China have begun to warm up, culminating in a meeting between Joe Biden and Xi Jinping that opens the door to a short-term respite in trade relations.
Japan: a structural change in view on inflation
In 2024, Japan should see a marked improvement in economic growth, supported by a favorable combination of inflation and a recovery in the manufacturing sector. We expect the Bank of Japan to end its Yield Curve Control (YCC) policy and exit the Negative Interest Rate Policy (NIRP) in the first quarter of the year. After years of deflationary expectations, Japan finds itself at a crucial juncture, with nominal variables behaving more normally.
1-year, 5-year and 10-year rates Japanese
Sources : Bloomberg, Groupe Richelieu
Economic growth has proved resilient despite weak external demand, and inflation expectations are now anchored at positive levels. Responding to rising domestic inflationary pressures and a falling currency, the BoJ began to ease its YCC. Nevertheless, it remains cautious, awaiting further evidence of inflation driven by domestic factors rather than pressure from imported costs. Confidence in the wage outlook is a key indicator for the BoJ in its assessment of inflation sustainability. At a time when other advanced economies are tightening monetary policy, the BoJ is hoping to take advantage of price pressures and boost the economy. There are signs that this is working: Japanese real wages are rising and the labor market is tight. Given Japan’s deflationary history, inflation is welcome and, so far, looks healthy. The spring wage negotiations of 2024 will be decisive for the future of Japanese monetary policy. Given current high inflation, solid corporate earnings and growing public pressure, we expect the results of these negotiations to be at least as robust as those of 2023. The BoJ should conclude in spring 2024 with a stable inflation target of 2%. On this basis, we expect the end of NIRP and YCC, probably as early as January 2024, or by April at the latest. These measures will not mean a tightening of policy, as real interest rates will remain extremely low. We do not foresee a rapid rate hike cycle and do not expect Quantitative Tightening (QT) to begin before 2025. Further increases of 25 basis points are expected inQ4 2024 andQ2 2025, taking Japan’s key rate to 0.5% by mid-2025. Japan’s fiscal policy supports this sustainable inflation. Since 2020, public spending has increased dramatically, replacing emergency pandemic spending with energy subsidies and income transfers to low-income households and pensioners. With elections on the horizon and little appetite among policymakers to cut spending, this trend is likely to continue, boosting growth in the short term.
Japan remains the best performer among developed countries. It is the only major economy whose growth will exceed its potential in 2024. Consumer spending is solid, while governance reforms adopted by the corporate world as a whole are helping to attract foreign capital.
This scenario of low growth and decelerating inflation is generally positive for assets, but there are many risks along the way. For the next few months, we are convinced that the market can believe in a “Goldilocks” state. Access to credit could become increasingly restricted. Persistent challenges in the commercial real estate market and the rising cost of financing for banks are likely to result in restricted access and more expensive financing for consumers and businesses who can still obtain credit.
The risks of slippage are numerous, whether political, geopolitical, economic, inflationary or financial.
Political risk : In 2024, we have elections in over 20 countries, including the United States, representing over 60% of the world’s GDP. With the rise of populism and polarization, we anticipate volatility linked to the political cycle. As geopolitics becomes more complex, oil prices are likely to rise, with Europe particularly exposed.
A second major risk for the US economy is ongoing political dysfunction. While Congress averted a government shutdown and, more importantly, a default by raising the debt ceiling until January 2025, persistent economic stagnation, combined with high immigration driven by wars in neighboring regions, could lead to a rise in support for extremist political parties. Finally, the US elections of 2024 could be a geopolitical turning point, as further aid to Ukraine is at stake, as are foreign policy predictability and the rule of law.
Geopolitical risk Three hot spots are set to remain the focus of attention until 2024: Russia-Ukraine, Israel-Hamas and China-Taiwan. The conflict between Russia and Ukraine has already shown that it can disrupt global markets, and it is likely to continue until 2024, as the Ukrainian counter-offensive seems close to an end, due to the approaching winter and concerns about the reliability of Western funding and artillery. The conflict between Israel and Hamas is already a human tragedy, but to date it has not spread beyond that. Expansion to include states like Iran could degenerate into a regional conflict with global economic and military implications. The most important geopolitical tensions in economic terms are those linked to China.
Taiwan status survey (Chengchi University)
Source : Chengchi University
Friction between China and the West is multi-faceted, with Taiwan a focal point in the short term. Taiwan’s elections in early 2024 will be a compass in the China Sea for the whole year.
Economic risk : an overheating US economy may yet lead to a tightening of global financial conditions, leading to a hard landing in the US. Fiscal excesses in developed countries pose an upside risk to global real interest rates. Chinese decision-makers may fail to stabilize expectations.
The most fragile balance sheet is in the hands of the public sector. The massive increase in public debt and the resilient budget deficit are putting pressure on real interest rates and crowding out private investment. Debt dynamics are not sustainable at current interest rates, unless significant fiscal consolidation is implemented in the future.
Inflationary risk : in the short term, disinflation scheduled to last a few months, a new shock or a prematurely accommodating monetary policy could set the stage for another wave of inflation. Generally speaking, the easiest job is being done: bringing inflation down from 8% to 9% to 3% to 4%, as base effects are in action. The transition from 3% to 4% to 1.5% to 2% will certainly be trickier. It’s also the fear of entering into a stop-and-go spiral of the 70s, which was a failure before Paul Volcker arrived. The conclusion of these two experiments seems obvious to us: central banks need to raise their interest rates to a fairly restrictive level, and at the same time to a level that does not oblige them to lower them in the event of a crisis. The episode involving the regional banks and the collapse of the SVB and some of its sister banks proved to be a good test. The Fed can act quickly and decisively, but will not change its strategy.
Fed balance sheet and rates
Sources : Bloomberg, Richelieu Group
It will therefore be some time before we can be sure that inflation is under control, or even until deflation risks return to the fore.
We are entering the new year with greater confidence in the economic situation. So let’s take advantage of a moment when the stars are aligned and the market believes in it, but let’s remain attentive and vigilant to paradigm shifts brought about by surprises that we’re sure will present themselves this year, 2024.
Allocation
We remain in the same vein as the previous month as far as macro-economic factors are concerned. We are convinced that, in the short term, the FED will set the pace. We have taken stock of the latest communications from the US central bank. Even if the desire to fight inflation remains firmly entrenched, we are convinced that the coming months will provide more scope for rhetoric and, above all, for action. The lags in the cumulative tightening of monetary policy are now having a tangible impact on economic activity and inflation. Gradual disinflation is taking hold, with good visibility over the coming months. Inflation expectations are moderating.
Graph : Inflation expectations
Sources : Bloomberg, Richelieu Group
The risk of a “hard landing” for the US economy is certainly higher, but our central scenario remains that of a soft landing that will avoid further rate hikes and aggressive rhetoric from central bankers.
The US economy has proved surprisingly resilient to Fed tightening. Business was surprisingly brisk, and rates exceeded our forecasts. In the United States, there is a contradiction between how the American consumer feels (confidence surveys are at an all-time low) and his actual state of health, which isn’t so bad! The latest employment surveys (payrolls, jobless claims) still show a picture of near-full employment, retail sales remain solid and real incomes are up.
US unemployment rate and consumer confidence
Sources : Bloomberg, Richelieu Group
We are keeping a close eye on the catalysts of another inflationary wave, but it seems to be somewhat postponed in our current scenario (in the US at least).
Volatility in interest rates is set to decline. Excluding exogenous events, this scenario should be favorable to risky assets, especially equities. We are raising our opinion on equities for the end of the year by a further notch across all regions, with a particular focus on Europe and emerging countries.
In Europe, the indicators published at the end of the month are improving and suggest some signs of inflection, potentially laying the foundations for positive momentum for the end of the year and the beginning of 2024. Improvements seem to be widespread, particularly in the German manufacturing sector (finally !).
Economic indicators in Germany
Sources : Bloomberg , Richelieu Group
However, we will have to watch out for inflationary pressures arising from this improvement (pressure on costs). After a period of moderation, they show some signs of intensification.
As regards emerging countries, a moderation in US monetary policy and the resulting fall in the dollar should enable a positive phase in the region.
The challenges remain the same across the three main geographic zones. Europe is at risk of stagflation, China at risk of deflation (a classic phenomenon after a real estate crisis of this magnitude). But as we explained in our forward-looking analysis, as long as the market remains focused on ” soft landing ” and disinflation, the momentum gained since early November can be sustained. The return to a goldilocks scenario in the market is fuelling this renewed optimism. (In economics, the “goldilocks” scenario refers to an optimal situation where growth is modest, but real, and inflation moderate).
As far as interest rates are concerned, we are not currently in favor of central bank rate cuts in the US or Europe. Cyclical factors are not all that negative, and structural inflationary pressures remain lurking in the shadows. There will be no tightening of spreads (reflecting a mild recession), nor any significant downward movement in rates that would allow prices to appreciate. The bond segment as a whole offers appreciable yields. Yield curves are set to flatten over the coming months, as markets no longer anticipate a rate cut over 2024.
Euro swap curves
Sources : Bloomberg, Richelieu Group
We will maintain a measured duration (2-4 years), being selective about issuers and seeking yield to offset a rise in the longer segments of the curve. Euro investment grade credit spreads include a slight recession, which we validate from a macro-economic point of view. Credit indicators support our positive fundamental view of the asset class. The sharp rise in interest rates and the economic slowdown will lead to lower financing and refinancing requirements next year in the Corporate Investment grade sector. We prefer bank bonds to corporate bonds, given current valuation levels and recent third-quarter earnings releases, which underline the sector’s robustness.
IG corporate CDS versus senior bank CDS
Sources : Bloomberg, Richelieu Group
From a portfolio construction point of view, only US sovereign bonds and, to a certain extent, US IG bonds can be satisfied with longer durations for diversification purposes, in the event of a more intense economic downturn. If there is a rate cut, it will come from the United States.
Let’s not forget that 2023 is a special year compared to previous years. There have been no exogenous shocks impacting either supply and demand or world trade. 2024 could be a different story.
Allocation Table
