The key theme for investors in coming months will be whether the US Federal Reserve (Fed) and other central banks can join the Swiss National Bank (SNB) and start cutting interest rates after aggressively tightening conditions in 2022 and 2023 to curb inflation.

Our table of GDP forecasts below shows economic growth is set to slow this year after the last couple of years of interest rate hikes. Slower growth - with Germany and the UK having already suffered recession at the end of last year - may help reduce inflationary pressures sufficiently to enable central banks to pivot towards rate cuts from summer.

We expect the Fed, the European Central Bank (ECB) and the Bank of Canada (BOC) will start reducing interest rates from June and the Bank of England (BOE) from August. Currently, the fed funds rate, the ECB deposit rate, the BOC overnight rate and the BOE Bank Rate stand at 5.25-5.50%, 4.00%, 5.00% and 5.25% respectively. A summer start should enable the Fed, ECB and BOC to reduce interest rates by 25bps each quarter for three cuts in total this year. The BOE, though likely to start later given higher levels of inflation in the UK, may cut interest rates by 25 basis points (bps) at each of its last four meetings of the year including August, while the SNB is also set to cut 25bps again twice to 1.00% by September.

Gradual rate cuts will benefit financial markets, by reducing fears that European economies will stay in recession and by raising hopes that the US may avoid a recession in 2024. The People’s Bank of China (PBOC) may also ease financial conditions in the next few months and even the Bank of Japan (BOJ), having raised interest rates in March for the first time since 2007 – from negative levels of -0.10% back to 0.00-0.10% – gave no signals it would hike rates further this year.

Central bank officials, however, will still want to see more progress first on lowering inflation before acting. Thus, monthly inflation data will be closely followed to see if monetary policy can be eased from the summer to the benefit of financial markets.

US – The Fed lowers the bar for rate cuts

The Fed’s new forecasts issued at last month’s policy-setting Federal Open Market Committee (FOMC) meeting lowered the bar for interest rate cuts this year while also potentially reducing the risks of a US recession in 2024.

The FOMC revised its 2024 projections up sharply for GDP growth from 1.4% to 2.1% and core inflation from 2.4% to 2.6%. But officials continued to forecast three 25 basis points (bps) rate cuts this year. Thus, the FOMC signalled core inflation just needs to dip from current levels of 2.8% to 2.6% during 2024 for the Fed to start easing.

The FOMC’s willingness to tolerate inflation staying well above its 2% target while it still prepares to cut rates is clearly dovish and supportive of risk assets. It may also be enough to avert a recession if US growth does not falter before the Fed cuts rates.

Our longstanding view has been the US would suffer a mild recession in 2024 after the Fed’s rate hikes in 2022 and 2023. Pandemic savings are falling, resulting in slowing consumption and retail sales. The unemployment rate has also risen from 3.4% at the start of 2023 to 3.9% in February. We thus forecast Fed rate cuts and recession risks will push 10-Year (10Y) US Treasury yields back to last year’s lows of 3.25%.

If the Fed, however, is willing to cut rates even if core inflation is well above 2%, then the US may achieve a soft-landing instead. We will thus keep watching the US data over the next few months to see if our view of a mild recession will still hold.

For example, if unemployment rate keeps rising over the next few months above 4.0% before the Fed cuts rates, then our base case for a mild recession in 2024 will become increasingly likely. Financial markets would react by pushing 10Y UST yields sharply lower towards our forecast of 3.25%. If, however, US growth remains steady while inflation dips further and enables the Fed to start easing rates from the summer then the risks of recession this year will recede. In that case, 10Y UST yields would still fall on lower Fed rates – likely towards 3.75% – but less than if the US economy were to suffer a recession.

China – Weak links still visible

The latest data shows China’s recovery continues to be held back by the economy’s weak links. We therefore think further easing will be needed to hit this year’s 5% GDP growth target.

On the positive side, activity may be stirring rather than fading. February’s purchasing managers’ indices (PMI) showed sentiment in services improved for the fourth month. Inflation was positive for the first time in five months with consumer prices 0.7% higher than a year ago. February’s exports and industrial production surprised, rising around 7% from a year ago and February’s fixed asset investment was 4.2% higher than a year ago as government borrowing boosted infrastructure spending.

But the economy’s weak links – lagging consumption, low confidence and sliding real estate – remain. Retail sales were only 5.5% higher than a year ago. February’s credit growth also disappointed only rising 9.0% over the last 12 months while investment in property still contracted by a sharp 9.0% over the past year.

China’s 2024 Work Report noted the government would take the rare step of issuing CNY1t of ultra-long bonds for strategic investments. We think officials will enact further fiscal and monetary easing to support growth. But the catalysts for a strong recovery – fiscal aid for consumers, less geopolitical tensions – still seem lacking at present.

Europe – Subdued growth still

Following recessions in the UK and Germany in the second half of last year – after higher inflation, higher interest rates and the energy shock from the war in Ukraine all hurt growth – activity this year has started to pick up across Europe as the latest PMIs of firms’ confidence show.

But officials remain concerned that tight labour markets after the pandemic will keep inflation sticky. We think the ECB and the BOE will wait until June and August before starting to cut interest rates from 4.00% and 5.25% respectively to support activity. We thus forecast GDP growth will remain weak at just 0.4-0.5% for the UK and the Eurozone this year.

Japan – The BOJ stays dovish after its first hike since 2007

In March, the BOJ ended its decade-long measures to beat deflation after judging its 2% inflation target was likely to be achieved on a sustained basis following the shocks of the pandemic and the war in Ukraine. The BOJ eliminated negative interest rates by raising its deposit rate from -0.10% and set its overnight call rate at 0.00-0.10%. It also scrapped its cap on 10Y Japanese Government Bond (JGB) yields and ended purchases of exchange traded funds (ETFs), real estate investment trusts (REITs), commercial paper and corporate bonds.

The first BOJ rate hike since 2007 came earlier than our forecast of April. But importantly for equities, the BOJ kept its outlook dovish still. First, the BOJ said financial conditions would stay accommodative and gave no signal that further rate hikes were likely. Second, the BOJ will still print money and buy bonds near its current pace of 6 trillion Japanese Yen a month to stop yields from rising sharply.

The BOJ thus seems unlikely to follow up on its dovish rate hike with further tightening anytime soon. We thus see the BOJ continuing to support Japan’s strong equity market rally this year.

Source: Bank of Singapore

Source: Bank of Singapore