The economic outlook has been favourable so far this year for investors.

In the US, slower growth and falling inflation should allow the Fed to start cutting interest rates from September. In Europe, growth is recovering from last year’s recessions. At the same time, the European Central Bank (ECB), the Swiss National Bank (SNB) and Sweden’s Riksbank have all begun reducing interest rates.

In China, firm manufacturing and exports are keeping growth on track to meet the government’s 5% target for 2024. And the Bank of Japan (BOJ) has only slowly begun to increase interest rates to ensure inflation settles around its 2% target in Japan.

However, the second half of 2024 may be challenging as several major economies hold elections.

The most important one will be the US election in November. If President Joe Biden wins, then inflation is likely to keep falling and the Federal Reserve (Fed) could cut interest rates. But if former president Donald Trump returns, then steep tariffs, tight immigration and larger budget deficits may reignite inflation.

We have raised our 12-month forecast for 10Y US Treasury (UST) yields from 3.75% to 4.25% to reflect the risk of US inflation rebounding next year. We therefore recommend investors take a more Neutral position on fixed income while keeping a modest Overweight position in equities.

US – Elections this year may boost inflation next year

The US economy is slowing. May’s retail sales only rose 0.1%, unemployment hit 4.0% and the core consumer price index (CPI) inflation fell to 3.4%. We thus expect the Fed to cut its fed funds rate from 5.25-5.50% in September by 25bps and again in December.

But while the US economic cycle points to lower interest rates, bond yields and a US Dollar, it could clash with the political cycle after November’s elections. A change in the White House may spur inflation next year. We thus update our forecasts for risks of a sharp change in US policies in 2025.

If President Biden returns, then current US policies - large budget deficits of 6% of GDP on infrastructure, semiconductors, and renewables; targeted tariffs, and looser immigration controls - are likely to stay. We think the Fed under a Biden administration would continue to cut rates each quarter in 2025 towards 3.75-4.00% as inflation nears its 2% target.

In contrast, if former president Trump wins, then inflation and inflation expectations may rebound in 2025, making the Fed pause or halt rate cuts. First, the US fiscal deficit will likely increase, especially if the Republicans also win Congress, as Trump wishes to extend the tax cuts passed in 2017 during his first term, that will expire in 2025.

Second, Trump plans to impose a sweeping 10% tariff on all US imports and 60% on Chinese exports. Third, Trump aims to sharply curb immigration, likely tightening the US labour market. Lastly, pressure on the Fed to cut rates would raise inflation expectations.

We think Trump’s policies will lift interest rates. Bond yields reflect growth (real yields) and inflation risks (breakeven rates). Tight tariffs and immigration may hurt growth, lowering real yields but higher inflation expectations may force overall bond yields up.

We thus keep our view of two 25 basis points (bps) Fed cuts this year but see only one in the first half of 2025 given November’s unknown result. We also raise our 10Y UST yield forecast from 3.75% to 4.25% to reflect the risks of inflation rebounding next year.

China – On track to reach the 2024 target of 5% growth

May’s data showed China’s GDP growth remains on track to meet its 5% goal for a second year but the economy’s uneven recovery from the pandemic still requires stimulus to stay on target.

China’s supply side remains firm. In May, industrial production expanded 5.6% year-on-year (YoY). Demand for China’s exports and manufacturing goods is also firm. Last month, exports rose 7.6% YoY and manufacturing investment increased 9.6% YoY.

But overall demand is still subdued. May’s inflation rate was just 0.3% as consumers stayed cautious and real estate remained fragile. Retail sales only rose 3.7% YoY and property investment contracted 10.1% YoY.

Underpinning the lack of demand is weak credit growth at just 8.4% YoY in May. Though government borrowing exceeded CNY1 trillion last month as the Ministry of Finance began issuing ultra long-term bonds for strategic investments, private demand for loans was weak.

We thus keep our 5.0% GDP growth forecast for 2024 but still expect further fiscal, monetary and property measures will be needed to support growth. Aside from the Ministry of Finance’s new bonds, officials have cut minimum property downpayment ratios and set up a CNY300b relending scheme for state-owned enterprises (SOE) to buy unsold houses. This year, the People’s Bank of China (PBoC) may still need to cut interest rates too.

Europe – Cautious on near-term outlook

Europe’s outlook has been favourable this year. Growth is recovering from last year’s recessions. At the same time, the ECB, the SNB and Sweden’s Riksbank have all begun reducing interest rates as inflation has fallen. We expect the ECB to reduce its deposit rates three times this year following June’s initial 25bps cut from 4.00% to hit 3.25% in December. Similarly, we expect the Bank of England (BOE) to make two 25bps cuts to its 5.25% Bank Rate in August and November.

Despite this, the recent elections in France and the UK highlight underlying political risk in Europe. Investors should be cognisant of this when it comes to European markets.

Japan – Weak Japanese Yen set to spur next BOJ rate hike

The Bank of Japan (BOJ) is set to follow its March interest rate rise with another hike in July as core inflation is settling around its 2% target and as the weakness of the Yen is raising import prices. We expect the BOJ to lift its overnight call rate from 0.00-0.10% to 0.25% this month. Officials will still likely be dovish and signal that further rate rises will only be gradual as the BOJ wants to ensure Japan does not return to its lost decades of deflation. But the risk of higher interest rates and an eventual rebound in the Yen makes the outlook more testing for Japan’s equities now after their record rallies over the past year.