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Global Outlook

May 2024

Waiting for rate cuts

While a soft landing for the US, firmer growth in Europe and resilient activity in China and Japan will benefit risk assets, uncertainty about monetary policy continues to be a key risk to the outlook.

Eli Lee
Managing Director,
Chief Investment Strategist,
Chief Investment Office,
Bank of Singapore Limited

The global economy is seeing two conflicting changes this year.

First, growth is becoming more balanced across the major economies.

The US has begun to slow after the Fed’s interest rate hikes in 2022 and 2023. But activity remains solid - so we no longer expect a mild recession in 2024 now. At the same time, growth has begun to pick up in Europe after the UK and Germany fell into recession last year. Purchasing manager indices (PMI) - a key survey of confidence - have reached their strongest levels in a year as falling inflation supports consumption. We thus see GDP growth beginning to improve in Europe after last year’s weak expansions.

Similarly, activity in China and Japan is proving more resilient than feared at the start of the year. The Chinese government remains on track to achieve its annual target of “around 5% growth” after 1Q2024 data showed GDP expanded by 5.2% compared to a year ago while April’s PMI survey hit its highest level for a year in Japan.

Second, inflation, in contrast, is proving more challenging causing investors to scale back their expectations for interest rate cuts. For example, we think the Fed will now only reduce interest rates twice this year, starting in 3Q2024, as firm US growth has kept inflation well above its 2% target. At the start of 2024, we thought three cuts were likely to the fed funds rate of 5.25-5.50%.

Thus, while a soft landing in the US, firmer growth in Europe and resilient activity in Asia will benefit risk assets globally, uncertainty about monetary policy continues to be a key risk to the outlook. Further rate cut delays would test financial markets. But importantly we do not expect central banks to re-start rate hikes - a development that would cause major declines in equity and bond markets around the world.

US – Three key changes to the outlook

The US economy has begun to slow after the Fed’s rate hikes but growth still remains solid. We thus make three key changes.

First, we no longer expect a mild recession this year. In 1Q2024, GDP expanded at a 1.6% annualised rate - sharply lower than its fast growth in 3Q2023 and 4Q2023 - as inventories, imports and the fading impact of America’s large budget deficit slowed activity. But consumption and investment were firm showing underlying demand is still strong. We expect annual GDP growth will slow from 2.5% in 2023 to 2.1% in 2024 as fiscal stimulus and pandemic savings ease. But instead of a recession, the US seems set for a soft landing of easing growth, falling inflation and Fed rate cuts.

Given the uncertain outlook after the pandemic, we ascribe the following probabilities for the US.

No Landing (20%) - growth remains strong, core inflation stays nears 3%, the Fed keeps interest rates high, and the economy avoids a recession.

Soft Landing (50%) - growth slows, core inflation falls below 3%, the Fed cuts rates and the economy avoids a recession.

Mild recession (20%) – growth slows, core inflation falls below 3%, the Fed cuts interest rates but the economy shrinks for two quarters.

Hard landing (10%) - growth slows, core inflation stays near 3%, the Fed keeps interest rates high, the economy suffers a deeper downturn later.

Second, we think the Fed will only reduce interest rates twice this year, starting in 3Q2024, as firm growth has kept core inflation well above its 2% goal. Third, we think fewer Fed rate cuts and a soft landing rather than a recession makes it unlikely 10Y US Treasury (UST) yields will fall back to last year’s lows of 3.25%. We thus raise our 12-month forecast to 3.75%.

A soft landing will support risk assets. But investors should still favour UST to hedge against the uncertain outlook this year. The key risks now to bonds are whether the Fed will resume rate hikes to curb inflation or an oil shock from the Middle East. The Fed, however, seems willing to be patient on inflation and thus appears unlikely to shock 10Y US Treasury yields higher from their current levels by deciding to increase interest rates again this year.

China – Firmer growth despite weak spots

For the second quarter in a row, China’s GDP expanded in line with the government’s annual target of “around 5% growth”. In 1Q2024, the economy was 5.3% larger than a year ago, slightly up from its 5.2% year-on-year (YoY) growth rate in 4Q2023.

The latest data supports our view that China’s lacklustre reopening from the pandemic last year was not the start of a prolonged period of stagnation. Instead, we expect GDP growth for 2024 as a whole will be solid at 5.0% after the economy expanded by 5.2% in 2023.

The 1Q2024 GDP report and March’s data show China’s weak spots remain. Consumption has dimmed after three years of lockdowns with retail sales only rising 3.1% YoY. Credit growth is also weak, up only 8.7% YoY as demand for new loans remains subdued, and confidence in real estate continues be low. Investment in the sector contracted sharply by 9.5% YoY in March.

But business sentiment is picking up again. Manufacturing and infrastructure investment increased 9.9% YoY and 6.5% YoY in March supported by stronger government borrowing for strategic industries. April’s PMIs showed manufacturing confidence in expansionary territory for the second month in a row after a full year of contraction. We thus see stabilising growth putting a floor under risk assets this year after China’s financial markets fell from 2021 to 2023.

Europe – Waiting to cut interest rates

This year, growth has begun to pick up in Europe with PMIs at their strongest levels in a year as falling inflation supports consumption. We thus see GDP growth beginning to improve in Europe after last year’s weak expansions and recessions.

Firmer growth will support the region’s financial markets. In addition, the two largest central banks - the European Central Bank (ECB) and the Bank of England (BOE) - both remain on track to start cutting interest rates this summer as inflation recedes. We expect the ECB will make three 25 basis point (bps) quarterly cuts to its 4.00% deposit rate from June while the BOE will likely start in August reducing its Bank Rate from 5.25%. Firmer growth and lower interest rates will benefit European risk assets this year.

Japan – The BOJ was dovish in April after its March hike

Last month, the Bank of Japan (BOJ) kept its overnight call interest rate at 0.00-0.10% - as widely expected - after raising interest rates at its prior meeting in March for the first time since 2007. But the BOJ kept a surprisingly dovish stance to the benefit of Japanese equities.

First, the BOJ issued new forecasts predicting core inflation would settle around its 2% target but said it would continue with quantitative easing as agreed at its meeting in March.

Second, the central bank said monetary conditions would need to stay loose to support the economy and third, Governor Ueda played down the weakness of the Yen on inflation.

We think dovish officials may only consider one further 15-25bps rate hike now this year, raising the BOJ’s overnight rate from 0.00-0.10% to either 0.15-0.25% or 0.25-0.35% to keep lightly curbing inflation. The BOJ is therefore set to continue supporting Japan’s equities this year.

Source: Bank of Singapore

Source: Bank of Singapore

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