Macro Update – October 2024
Macro Update – October 2024
Looking at the macro data from the last two months in the U.S., there’s no sign of a significant short-term recession risk. This is great news, though it means the Fed will likely reduce interest rates less than the market has expected, especially in 2025.
In the Eurozone, activity remains sluggish, and combined with declining inflation, the ECB is expected to lower rates again this October. Despite slower-than-expected European growth this year, we believe private consumption remains strong, and consumer confidence is improving, which could lead to a recovery soon.
On a positive note, China is ramping up stimulus efforts, which should help meet its growth targets. Meanwhile, the UK economy shows resilience, emerging Asia (excluding China) remains strong, and Japan’s outlook is favorable with wages growing faster than inflation, supporting consumption.
Given all this, we maintain a cautiously constructive view on risk assets, expect more upward pressure on long-term interest rates, and have become more favorable toward the U.S. dollar since mid-September, using it as a hedge against risks from the Middle East conflict and U.S. elections.
U.S.
U.S. macro data not only shows no recession risk but indicates growth in line with or slightly above potential in Q3.
The resilience of the U.S. economy increasingly suggests that the neutral rate may not be much below 4% nominal. This will have significant implications for the Fed’s monetary policy in the coming quarters. While we still expect two more 25bps cuts this year, we foresee few additional rate reductions in 2025. The terminal rate could be reached as early as Q1 next year, likely around 4%, aligning with our neutral rate estimates.
Eurozone
The Eurozone, this time because of countries like Germany, continues to show no signs of recovery. Combined with improving inflation, this will likely lead the ECB to cut rates in both October and December.
At the same time, there are strong reasons to expect a significant rebound in private consumption in the Eurozone over the coming quarters (historically low unemployment, wages growing well above inflation, strong household balance sheets, and a notable recovery in consumer sentiment).
Although market sentiment in the short term will focus on the ECB’s much more dovish stance since mid-September, we believe that in 2025, rates will fall much less than expected, with a terminal rate close to 3%.
Meanwhile, it’s encouraging to note that the UK economy has shown some strength.
Asia
China’s recent stimulus measures are significant and will help lay a solid foundation for economic activity.
At the same time, emerging Asia continues to show impressive growth and macroeconomic stability, with inflation generally well-managed and healthier fiscal conditions compared to many developed countries.
In Japan, wage growth exceeding inflation is expected to spark a macroeconomic recovery in the coming months. However, with no signs of economic overheating, the Bank of Japan is likely to remain patient on interest rate hikes. Although Japan’s new LDP leader was initially seen as favoring quicker monetary normalization, his recent statements emphasize overcoming deflation, signaling no support for hawkish policies from the BOJ.
Risk Assessment
We are closely monitoring risks related to the Middle East, the U.S. elections, and political and fiscal developments in France.
Regarding the Middle East, while uncertainty remains, we believe Israel is unlikely to pursue an aggressive response to Iran, focusing instead on Hezbollah in Lebanon and Hamas in Gaza. Even a direct conflict with Iran is unlikely to cause a lasting global economic shock due to the current crude oil surplus and Iran’s limited incentive to close the Strait of Hormuz.
As for the U.S. elections, while we don’t make a firm prediction, our central scenario sees a Kamala Harris victory, which could be positive for European and emerging market assets. However, the chance of a Trump win is significant enough for us to shift to favor long positions on the U.S. dollar and short positions on 10-year Treasuries as a hedge.
In France, Barnier’s ambitious deficit reduction plan focuses on controlling public spending rather than raising taxes. However, it’s uncertain whether the French parliament will support firm fiscal consolidation, so we remain cautious about exposure to French public debt.
Equities: Our macro outlook is positive, and we believe that, with caution around overpriced areas, a constructive equity exposure is still viable. We favor cyclical stocks over defensive ones, small and mid-caps, and a balanced approach between value and growth. Geographically, we prefer European equities (including the UK) over U.S. equities due to valuations and the potential for a private consumption rebound, supported by China’s stimulus and local improvements.
Government bonds: Although long-duration bonds performed well during recent market turbulence, we don’t see value at current yield levels. Terminal rates for central banks (like the Fed and ECB) are likely to be higher than the market expects, and fiscal concerns could lead to higher term premiums, particularly in France and potentially the U.S. if fiscal issues persist post-elections.
Corporate bonds: We remain positive on corporate credit, as company balance sheets are strong and default rates should remain low in a non-recessionary environment. However, given compressed spreads, we recommend combining credit exposure with select emerging market local-currency bonds, which offer attractive returns and potential currency appreciation.
Currencies: After staying out of USD most of the year, we now hold positions due to the U.S. economy’s strength and as a hedge against risks from the Middle East and the U.S. elections. Beyond emerging market currencies (like INR, IDR, BRL, MXN), we also favor developed market currencies with solid fundamentals, attractive inflation-adjusted carry, and fiscal health, such as NZD, AUD, GBP, CAD, NOK, and SEK.
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