We came into 2024 believing that a cyclical recession, featuring a moderate economic contraction followed by a return to growth, was the most likely scenario for 2024.
Three months in, markets are more positive - and so are we.
We continue to think through a scenario lens, tracking leading economic indicators alongside the on-the-ground insights of our research analysts. They’re telling us that economies are holding up; consequently, we’re happy to take on more risk. But we’re not yet convinced that central banks have won their battles against inflation.
So, for this quarter, there are three themes we’re paying particular attention to as we assess the outlook for developed markets. The first is the likelihood of a soft-landing scenario versus the increasing odds there will be no landing, and we witness a ‘mid-cycle’ environment.
Next is stabilisation in China, where prospects are improving, albeit slowly.
Finally, we’re monitoring the risks. Perhaps that should go without saying. However, there is a calmness to the markets now which belies the structural uncertainties. You can never pay too much attention to what could go wrong. A softening landing Inflation is falling and markets are proving resilient. These are good signs, and have prompted us to improve our base case for 2024 to a soft landing, where growth settles at (or slightly below) trend. That means economies will stay relatively healthy through the next nine months as central banks manage - and perhaps conquer - their inflation problem. An important variable for that trajectory this quarter is whether central bankers decide to cut rates. If and when they do, Europe is likely to accelerate its cuts compared with other developed markets. Data from the region shows some modest improvements in activity, particularly in services, and increasing consumer positivity as falling inflation weighs less heavily on wallets. The European Central Bank has already sent a strong signal that it could cut rates as soon as June. The situation in the US is harder to call. Inflation has rebounded in the opening months of 2024, with areas of stickiness persisting, plus growth forecasts are high and rising.
Strong data and persistent inflation present the ultimate bind for central bankers: any premature celebrations of victory over inflation would damage their credibility and de-anchor expectations. Alternatively, further hikes may drive the economy into recession. It leaves us increasing the probability of no landing to 30 per cent, up from 5 per cent at the start of this year. This scenario would involve economies holding at current levels of growth and inflation, provoking central banks into another, albeit incremental, round of policy rate rises.
The last mile in the race to beat inflation was always going to be the hardest; this quarter may reveal how much energy is left in central bankers’ legs.
Stabilisation, not acceleration, in China
China is engineering a ‘controlled stabilisation’ of its economy, as the country weathers a property downturn and seeks to rebalance away from debt-fuelled expansion towards consumption and high-end manufacturing. Growth momentum in the property sector continues to slow – but at the same time, its contribution to GDP has waned as the supply side of the economy takes over.
On the monetary side, we are not expecting any significant rate cuts by the People’s Bank of China before the US Federal Reserve (Fed) clearly pivots. Even if the Fed starts easing, rate cuts in China are unlikely to be aggressive; monetary easing will probably play a supporting role to fiscal measures this year.
Our forecast for China’s annual growth rate comes slightly below the official target, as we haven’t seen a strong enough policy commitment. We will be closely monitoring fiscal measures such as bond issuance by the central government in order to track China’s growth trajectory for the year.
The slowdown in China and wider geopolitical concerns have continued to support the ‘China plus one’ trend that has seen global firms reduce their reliance on the country’s exports. Parts of the ASEAN bloc, such as Vietnam and Indonesia, have already benefitted.
So too have countries closer to importers’ homes - Mexico, for instance, is an emerging market hotspot that continues to benefit from the US’ nearshoring of production.
That trend is likely to continue even as global demand wanes, though we are seeing encouraging signs that China’s economic activities are bouncing back. It appears the Chinese government is prioritising a stabilisation of growth, rather than an acceleration, in the short term.
Where lie the risks
We are more positive on the trajectory for this year, but we have not lost sight of the risks. The prospect of no landing is rising, and with it the threat that rates will rise once again.
Nor has the risk of recession disappeared entirely - principally, it is the timing that has changed. We maintain that the likeliest outcome is a soft landing for now, with recession delayed until next year.
This is largely because of the continued strain that abundant liquidity and fiscal looseness is placing on financial systems. US spending has been funded by draining the Fed’s Reverse Repo Facility close to zero. Fiscal largesse is supporting the economy through the US’ election year, but in the shadows lurk maturity walls and the refinancing burdens that will weigh on many companies next year. This could be the crunch point that central banks have, for now at least, successfully averted.
There are other risks too. A year of wars and elections means geopolitics are likely to leave a mark on markets, though it is difficult to predict how.
We are also closely monitoring the development of artificial intelligence (AI). Many of our analysts are reporting a boom in productivity at the companies they follow which is due in part to AI. Some firms appear to be embracing these advances; others will be forced to invest heavily in its development to avoid being left behind. That will disrupt markets and economies for years to come. We’re looking beyond Q2 here - none of this will happen overnight - but for all that AI promises, it also carries risks we are yet to understand.
That could serve as a mantra for the quarter ahead.
