Asset Management: Monthly Macro Insights - December 2023

Economic growth in advanced economies has been very weak in Q3-23, but the US was the notable exception, giving the impression the global economy remained resilient. Are we on a path of ‘immaculate disinflation’, or is the fall in inflation increasingly the reflection of a deteriorating economy?

Divergence unlikely to persist…

Growth in China has been volatile since the reopening of the economy at the start of 2023. While recent policy easing has increased investors’ confidence in their outlook for an improved growth profile during 1H24, recent data suggest that the momentum remains rather fragile.

Although not falling off a cliff, most advanced economies saw negative GDP in Q3-23. In sharp contrast, US GDP sharply outperformed, thus reassuring investors that the fastest monetary tightening in decades was not sufficient to derail the economy. Yet, the US’ outperformance was driven in large part by temporary factors that are unlikely to be repeated.

… and so does fiscal largesse

In the wake of the invasion of Ukraine by Russia, many governments have provided sizeable help to households and businesses to face the ensuing energy shock. Defence spending has also been raised in several countries. Furthermore, faster implementation of Next Generation EU plans has boosted expenditure in some European economies. In the US, higher spending on social security and healthcare, as well as lower-than-expected tax revenues, have generated an easing in the fiscal stance.

In fact, despite one of the fastest monetary tightenings in almost 40 years, the global economy’s resilience in the first half of the year has surprised most economists. However, the easing of fiscal policy played a central role in offsetting the negative impact of the monetary tightening. However, this policy mix divergence is now turning.

Are rate cuts’ expectations to be upset?

Headline inflation has come down quickly in most economies over the past year, and recent central bank communications suggest that the risk of further tightening has significantly receded. The rates market now incorporates relatively high probabilities of easing by both the ECB and FED in early 2024.

However, unit labour cost (ULC) growth remains high, and monetary policy likely needs to remain restrictive until there are clear signs that underlying inflationary pressures are durably lowered. Yet, inflation trends will take time to discern, and it is still far from certain that immaculate disinflation is even possible, i.e. to reach the inflation target without a significant weakening of economic activity. The latest surge in equity markets and the fall in sovereign yields, which are associated with investors’ greater soft-landing optimism, could ironically force central bankers to adopt a more hawkish tone as unwarranted easing in conditions jeopardizes their efforts to cool off the economy. Overall, investors’ rate cuts expectations might prove to be ill-advised… unless their resilience scenario turns out to be too optimistic.