US soft landing in sight

The US and broader global economy are clearly slowing. Consumers’ Covid-era savings stockpiles are almost depleted, interest rate-sensitive sectors such as manufacturing and housing are struggling, and the effects of past fiscal stimulus are fading.

The US labour market is cooling and unemployment is rising. This has triggered the ‘Sahm rule’, usually considered a reliable indicator of impending recession.

However, our baseline forecast remains for a ‘soft landing’ – where inflation is brought under control without triggering a recession. We think US growth will slow from 2.6% in 2024 to 1.7% next year, but will remain positive, supported by pro-active rate cuts.

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

A moderation in quarter-on-quarter inflation should support sentiment and real income growth. Trends in US rental prices suggest the sticky ‘shelter’ component of inflation will continue to cool, albeit only gradually. While inflation may still surprise – perhaps a sharp rise in oil prices on the back of more geopolitical shocks – we’re less worried than before about economies struggling with stubborn inflation.

Concerns shift from inflation to growth

Indeed, we think that ‘hard landing’ has replaced ‘no landing’ as the key risk – as concerns shift away from inflation to growth. 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 – as one falls, the other rises – 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 the US central bank to undertake a total of 100 basis points (bps) of rate cuts this year and 125 bps of cuts next year.

We expect the endpoint of this cutting cycle to be just below 3% for the benchmark fed funds rate. It is possible that wider labour-market or financial-market stress, or the Fed’s desire to get ‘ahead of the curve’, will trigger bigger cuts earlier on.

Easing to slow in Europe

European growth is cooling, with the German economy especially weak as it struggles with cyclical and structural headwinds. However, the European Central Bank (ECB) is still worried about underlying inflation risks, particularly the strength of wage growth. Having started cutting rates earlier than the Fed, this concern may now keep the ECB relatively more cautious when easing.

The UK economy is experiencing a cyclical upswing, which we expect to constrain the Bank of England to a quarterly pace of rate cuts this year and next. It’s too soon for the Labour government’s supply- side measures to boost trend growth, so, with fiscal space very limited, its first budget will involve tax increases. It’s possible that these will become a headwind to growth and sentiment in time.

Japan, China face different challenges

The Bank of Japan (BoJ) remains the major exception to global easing. Although the BoJ’s previous rate hike shook global financial markets, a significant increase in Japanese wage growth means policymakers want to continue moving interest rates up towards a more neutral stance. With the markets seemingly doubting the BoJ’s resolve to further tighten policy, this could cause another round of currency and broader market volatility.

Across the East China Sea, China’s real estate adjustment has further to run and will continue to constrain growth. A weak housing market is weighing on consumer confidence and will keep savings levels elevated. The troubled property sector also affects local government finances. That’s why it’s touch-and-go whether China will achieve its 2024 growth target of around 5%. We anticipate growth of 4.4% next year.

Chinese policy easing is likely to remain incremental and supply-side-biased, given the balance between growth and other objectives. This may further entrench disinflationary forces in the economy, although we think policymakers would intervene more forcefully if it looked like China was heading towards a prolonged period of deflation – dubbed ‘Japanification’.

Elsewhere in EMs and potential risks…

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, although resilient labour 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 think the potential return to rate hikes in Brazil is a harbinger of a broader turn in EM monetary policy. In fact, EM rate cuts are likely to broaden as the Fed eases.

Finally, our forecasts are conditioned on a Kamala Harris victory in the US presidential election in November, given her current lead in the polls. However, the race is close and her rival, Donald Trump, still has advantages on issues such as the economy and in the electoral college system of voting. A Trump presidency that pursues inflationary policies, such as tariffs and tax cuts, as well as political interference in monetary policy, is one of our key risk scenarios.

An oil price shock emanating from the Middle East is another source of external inflation risk. But a sustained improvement in the supply capacity of the global economy, perhaps spurred on by developments in artificial intelligence, may help keep prices in check. 

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