Markets have proven resilient to the prospect of recession. That they will continue to do so is far from certain.
Have central banks pulled it off? Tightening monetary policy appears to have brought inflation down from its peak without causing serious damage to the economy. But it’s not yet ‘job done’. Inflationary pressures linger, while the prospect of higher rates for longer and looming maturity walls make an unsettling combination.
The final quarter of the year tends to portend what is to come, and we believe the following three themes will determine the path for markets heading into 2024.
Diverging signals
Inflation has fallen during Q3. But beware: the headline data conceal a more nuanced picture.
There are signs that the transmission of tightening monetary policy has not fed through to the real economy as quickly as central banks would have hoped. Many companies, for example, are earning interest on their deposits but (having agreed multi-year terms) are not yet paying more for the debt they accumulated at ultra-low rates during the pandemic.
Ultimately, we believe the transmission mechanism is delayed rather than broken, and the situation could reverse rapidly - especially when corporates begin to refinance their debt next year.
Fidelity International’s analysts, meanwhile, on average are expecting moderate price rises over the next six months, noting lingering supply chain pressures within sectors such as industrials and communication services. The US Federal Reserve has not yet fixed its inflation issue.
Higher for longer?
Central bankers have learned from their mistakes two years ago and do not plan to underestimate inflationary pressures this time. So, the message seems clear: rates will remain higher for longer. But it’s a risky strategy, especially with corporate maturity walls coming fast into view. Many of our analysts expect a 15 to 25 per cent increase in interest expenses for companies they cover.
The situation remains sufficiently uncertain to lead us to believe a recession is still more likely than not. We estimate there is a 60 per cent chance of a cyclical recession, in which unemployment in the US rises to between 4.4 and 6.5 per cent over the next 12 months.
China - opportunity amid the uncertainty?
One impediment to China’s recovery since the pandemic has been a lack of confidence among consumers. This is in part due to the psychological toll dealt by years of lockdowns. But policymakers also recognise the importance on sentiment of key sectors like real estate. Chinese consumers are unlikely to spend while much of their wealth is locked in a declining housing market.
Beijing has lowered some hurdles to home purchases and mortgages in an effort to revive the sector, although we don’t expect mass stimulus when policymakers are on guard against a debt spiral. But these efforts to boost consumer confidence bode well for the market, as do bright spots such as an outperforming services sector. All the while equities trade at near-historic discounts to global markets. We have taken note.
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