However, “hard landing” has replaced “no landing” as the key risk. Indeed, sustained proactive monetary easing is necessary, and we expect consecutive cuts from the Fed.

Interest rate-sensitive sectors such as manufacturing and housing are struggling, and the fiscal impulse is fading. Most concerningly, the labor market is cooling, and unemployment is rising. This has triggered the Sahm Rule (Chart 1), usually an indicator of impending recession.

However, our baseline forecast remains for a soft landing. Growth will slow from 2.6% in 2024 to 1.7% next year but remain positive, supported by material rate cuts.

That’s because the signal from rising unemployment is weaker this time around, given that it’s being partly driven by rising labor supply from immigration and higher participation. Meanwhile, corporate profitability is still robust, mortgage delinquencies are low, and measures of household net worth are close to record highs.

In addition, the moderation in sequential inflation back to target-consistent rates should support sentiment and real income growth. Trends in rental prices suggest the sticky shelter component of inflation will continue to cool, albeit only gradually. While there are still plausible sources of upside inflation surprises, such as a sharp rise in oil prices on the back of further geopolitical shocks, we are less worried than previously about an endogenously generated, persistent inflation overshoot.

This is why we believe that “hard landing” has replaced “no landing” as the key risk to the global cycle. While our quantitative recession risk models, which incorporate a broad range of US economic data, are not flashing red, they have been creeping up recently. This shift in the risk environment means the equity-bond correlation may start to turn negative once again.

The moderation in inflation and increasing concern about the full-employment side of the Federal Reserve’s (Fed) dual mandate means we expect it to undertake a total of 100 basis points (bps) of rate cuts this year and 125 bps of cuts next year (Chart 2).

Source: Haver, abrdn, September 2024.

Our work on equilibrium interest rates means we expect the endpoint of this cutting cycle to be just below 3% on the fed funds rate. It is possible that wider labor market or financial market stress, or the Fed’s desire to get “ahead of the curve”, triggers more front-loaded easing.

US

Activity: The US economy is clearly slowing, raising fears that it might be heading towards a hard landing after all. We expect a further deceleration in GDP growth to run rates below 2% annualized in H2 as consumer spending slows in line with muted household income growth. However, we still expect a soft landing, helped by strong consumer and corporate balance sheets, slowing price pressures, and an ongoing easing in financial conditions. However, the risk of recession has increased, especially as there are signs of a concerning loss of momentum in the labor market.

Inflation: Underlying inflation pressure continues to cool, even if this process has been bumpy this year (Chart 3).

We expect further progress amid ongoing declines in core goods prices and labor costs, and a long-awaited easing in shelter inflation. This should keep sequential core PCE inflation prints around the Fed’s target, but annual inflation rates will not fall closer to 2% until early 2025 given unhelpful base effects. The outlook for price growth further ahead is clouded by an uncertain policy backdrop, with former President Donald Trump running on an inflationary policy platform.

Policy: Given the fall in sequential inflation, the Fed is now able to focus on securing a soft landing. Indeed, Chair Jerome Powell has made clear that the Fed would not welcome any further deterioration in the labor market. This implies a relatively rapid return towards neutral interest rates, where policy would no longer weigh on activity. We expect policy easing in every meeting until the middle of next year, when the pace may slow slightly. Even more rapid easing is likely if the data disappoints. Markets have also started to price at a lower equilibrium interest rate, which is consistent with our view.

China

China’s real estate adjustment, which has further to run, will continue to constrain growth. A weak housing market is weighing on consumer confidence and will keep the savings rate elevated. It also hits local government finances. Achieving the 2024 growth target of around 5% is on a knife edge and we anticipate a further slowdown to 4.4% next year.

Activity. China’s growth target of “around 5%” is on a knife edge. A weak Q2 GDP print and a modest start to Q3 have pushed our 2024 forecast down to 4.8%. Policymakers have signaled support to boost domestic demand is on the way, but an incremental approach to easing risks falling short of what is needed to spur the economy. With house prices continuing to fall and income expectations damaged, household saving will likely remain a headwind to growth. Should a trade war unfold under a second Trump presidency, we believe 2025 GDP growth would fall below our 4.4% forecast.

Inflation. Even if activity data is not weak enough to spur an aggressive policy reaction, questions remain as to whether China is sleepwalking into ‘low-flation’. Headline CPI inflation was positive for the seventh month in a row in August, but it is still advancing at a tepid pace of only 0.6% year over year. The incremental and supply-side biased policy mix, which favours investment in strategic industries over consumption, implies ‘low-flation’ will be hard to shake (Chart 4). Fears of ‘Japanification’ may be overstated, but we expect annual CPI growth of just 1% next year, below consensus expectations of 1.5%.

Policy. An accelerated pace of government bond issuance and further small rate cuts by the People’s Bank of China (PBoC) should reduce the risk that growth falls well below target. That said, the emergence of financial stability concerns, which motivated an intervention to stem the rally in long-dated bonds, suggests a cautious approach to easing. The Third Plenum also revealed little indication that the authorities are considering a more forceful stimulus, asserting that security remains the ‘foundation’ for China’s technology-focused modernization. This implies that resilience is being prized above growth, which will continue to amplify tensions with the West.

Given the balance between growth and other objectives, we believe Chinese policy easing will remain incremental and supply side biased. This may further entrench disinflationary forces in the economy, although we believe policymakers would intervene more forcefully if it looked like China was heading towards “Japanification.”

Emerging markets

Broader emerging market (EM) growth appears to be robust but cooling. Headline inflation has returned to central banks’ targets across a growing number of EMs. However, resilient labor markets and volatility in food prices and exchange rates are now slowing the pace of disinflation in some economies. While this has caused the EM easing cycle to pause, we don’t believe Brazil's likely return to rate hikes is a harbinger of a broader turn in EM monetary policy. EM rate cuts are likely to broaden as the Fed eases.

India

Activity. We believe Indian economic growth will slow over the coming quarters, albeit continuing to outperform global growth. While the economy slowed more sharply than expected in Q2, the breakdown revealed a still healthy domestic private sector. Tailwinds from public infrastructure spending and exports will ease in the coming quarters, and there will be a greater onus on the private sector to drive growth. However, much will depend on the pace of reform to spur investment and job creation in more productive sectors. Still, risks are skewed to the upside, especially as a strong harvest could boost rural demand.

Inflation. Inflation continues to be driven by rising food prices, stalling the broader disinflation process in India. While core inflation has been well anchored, food prices have been spiking due to adverse weather conditions (see Figure 9). The progress of the remainder of the monsoon season will be crucial, with initial signs pointing to a good harvest. A strong harvest should cool, or at least stabilize, food prices, helping to slow the month-over-month increases in headline inflation (Chart 5). Coupled with lower oil prices, it should bring inflation closer to the Reserve Bank of India (RBI)’s 4% inflation target mid-point.

Source: Haver, abrdn, September 2024.

Policy: The RBI has held its policy rate at 6.5% since February 2023, highlighting the importance policymakers are putting on food prices and the risks of higher inflation expectations. Indeed, we forecast the RBI to maintain its current policy stance over the rest of the year until the outlook for food inflation improves. We expect policymakers to tolerate some slowing of activity in the near term and look past the Fed’s easing cycle. As food price risks recede, we expect a modest easing cycle to ensue in early 2025.

Mexico

Activity: The Mexican economy’s momentum has faltered in recent quarters. Indeed, Banxico’s latest forecast projects annual growth of just 1.5% in 2024 and 1.2% in 2025 (down from 2.4% and 1.5% previously). However, low unemployment, the gradual normalization of inflation, and supportive fiscal policy will buoy domestic demand over the coming quarters. A more material slowdown in the US would be a significant headwind for the Mexican economy, while greater protectionism under a Trump presidency could hurt trade and investment.

Inflation: After accelerating from 4.4% year over year in February to 5.6% in July, Mexico’s headline inflation rate slowed to 5.0% in August. The prior rise was largely due to rising food prices, which will continue to hinder disinflation in the coming months. However, core inflation has maintained a downtrend since early 2023, with our preferred measure marginally above Banxico’s 3% target. Softening domestic growth should further contain core domestic price pressures. However, peso depreciation could exacerbate import price growth, keeping inflation expectations stubbornly high.

Policy: Banxico’s easing cycle this year has been cautious, with two 25bps cuts in March and August. In the future, the Fed’s easing cycle will provide room for Banxico to cut further without sharply widening its real rate differential with the US. However, with concerns regarding the new government’s strengthened legislative powers, fiscal stance, and US presidential election uncertainty weighing on the peso (Chart 6), Banxico will take a more cautious path in cutting than the Fed over the near term unless investor sentiment materially improves.

Finally, an oil price shock from the Middle East is another source of exogenous inflation risk. At the same time, a sustained improvement in the global economy's supply capacity, perhaps spurred on by developments in AI, remains a critical upside risk.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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