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Unfurling the Sails (a little)



 

The outlook for the US economy continues to be more positive than most expected given better than forecast growth and cooling inflation. In this month's Insight we review the economic landscape in the US as the Federal Reserve points to interest rate cuts and what this means for investors.


Key Points:

  • Global economic growth has improved a little and the US economy remains very resilient. However, progress towards lower inflation has slowed.

  • Reasonable growth and lower interest rates have historically been a good combination for global markets. If a recession is avoided, and rates are cut this year, 2024 could be another good year for returns.

  • Valuations for mega-cap technology stocks are pricing this rosy outcome, but other areas of the market are much cheaper and have room to grow should growth accelerate from here.

  • The risk of a recession is still high, as is the risk inflation creeps higher, so we expect portfolio activity will be higher this year to navigate these risks.

 

With interest rates being hiked meaningfully, a recession, which has been the most common consequence of hiking cycles historically, loomed large as a risk during this period. Since then, a number of major economies have suffered weak economic growth or even technical recessions. However, US economic growth has shown remarkable resilience and the US economy ranks first, second and third place in terms of importance for global markets. Based on higher frequency data and some leading indicators, there doesn’t seem to be an imminent risk of a recession in the US in the near term. Indeed, global economic growth actually began to improve late last year.


Counterbalancing this positivity has been slowing progress on lower global inflation. Inflation in the US has accelerated a little in the past few months and remains somewhat sticky in a number of other countries. This trend will make it more difficult for the Federal Reserve and other central banks to deliver their projected rate cuts this year.



There are some positive signs on this front. The US labour market has rebalanced considerably while (so far) avoiding a material increase in the unemployment rate. This has seen wages growth slow to a more sustainable level. Rent price growth is also slowing and should continue to do so as more apartment supply comes online. These factors should support ongoing normalisation in inflation as long as there isn’t a substantial re-acceleration in growth. Weak economies should deliver softer inflation in other countries, including Australia.


The Pre-emptive Pivot


If the Federal Reserve and other central banks begin to cut interest rates from around the middle of this year, this will mark a key difference from previous monetary tightening cycles. Normally, central banks hike rates too far, drive the economy into a recession and then ease policy too late. Interest rate cuts this year mechanically lower the risk of a recession because it gives central banks a jump start on supporting growth.


The pivot away from tightening has also led to easier financial conditions as long term interest rates have priced in rate cuts and equity markets have rallied. Likely in response, some of the leading indicators which had been pointing to a recession in the US have begun to improve. Importantly, bank lending standards are on track towards easing again, which should support credit growth in the economy, particularly in an environment of lower interest rates.  




Fiscal Dominance


Another major factor specific to the US is the impact of fiscal policy. This, alongside a very high proportion of long term mortgages that were fixed at very low rates, goes a long way to explain the divergence in economic growth between the US and the rest of the developed world in the last couple of years. The US federal budget deficit has widened significantly since mid-2022, by around 3% of GDP. Normally in an environment of strong economic growth, it would be narrowing, dragging on growth. The deteriorating fiscal position reflects a combination of lower tax receipts and increased spending, but the net effect has been substantial support to the US economy, likely doing a lot of work to offset the impact of higher interest rates.



Source: LSEG Datastream, Drummond Capital Partners


With an election this year, both major political parties in the US are unlikely to take any steps to rectify this problem. If Trump is elected, more corporate tax cuts are probably coming. If Biden is re-elected, we can expect more social and climate transition related spending.



A Manufacturing Renaissance


There also seems to have been a turnaround in the global manufacturing cycle, including in the US. Historically, this has coincided with stronger economic growth overall and an improvement in corporate earnings growth. Even if this is driven by the global inventory cycle, it will support overall growth. The JP Morgan Global PMI is back above 50 (which signifies expansion) for the first time since mid-2022.




Buckle Up


While most of the above sounds positive, there are a number of obvious key risks to the outlook. There is still a reasonable risk of a recession. The lags between the monetary cycle and economic activity are long. Just because there hasn’t been an obvious macro impact from higher interest rates in the US yet doesn’t mean there won’t be one eventually. Households globally have also drawn down pandemic stimulus savings, which could see retail spending soften from here. Potential weakness in labour markets is key to monitor here. Unemployment rates globally have been creeping up and the risk is that this accelerates.





Otherwise, if a recession is avoided, we think interest rate cuts this year and continued high (or higher) US Government spending are a recipe for renewed inflation pressure in late 2024, or early 2025. This would see rate cuts priced out and rate hikes potentially re-entering the equation. In our view, this would see long term interest rates begin to rise again, likely triggering valuation concerns around expensive technology companies.



 

Disclaimer:

Prepared in conjunction with our external investment consultants Drummond Capital Partners (Drummond) ABN 15 622 660 182, AFSL 534213. It is exclusively for use for Symmetry clients and should not be relied on for any other person. Any advice or information contained in this report is limited to General Advice only.


The information, opinions, estimates and forecasts contained are current at the time of this document and are subject to change without prior notification. This information is not considered a recommendation to purchase, sell or hold any financial product. The information in this document does not take into account any of your objectives, financial situation or needs. Before acting on this information recipients should consider whether it is appropriate to their situation. We recommend obtaining personal financial, legal and taxation advice before making any financial investment decision. To the extent permitted by law, Symmetry Group Pty Ltd makes no warranties or representations about the accuracy or completeness of the content of this publication and excludes any liability which may arise as a result of the use of the content of this publication. Past performance is not a reliable indicator of future performance.


This report is based on information obtained from sources believed to be reliable, we do not make any representation or warranty that it is accurate, complete or up to date. Any opinions contained herein are reasonably held at the time of completion and are subject to change without notice.

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