Is the soft-landing still on track?
Markets have become more turbulent amid fears that the US economy is slowing. We could see further evidence of a slowdown as higher interest rates take their toll and employment growth slows. But rate cuts in the UK, Europe and China should support global growth.
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The US economy defied forecasts of a slowdown for over two years. Despite interest rates at the highest level in decades, GDP expanded at an impressive rate and the employment market remained strong. There are now signs that America’s economy is starting to cool. This led to a sharp rise in volatility in global stock and bond markets over the course of the third quarter.
The most worrying signs of a slowdown have been in job creation, a hallmark of economic expansion. The US is still adding jobs, but the pace has slowed in recent months (see chart below). The unemployment rate has also been steadily rising for around a year. While unemployment remains relatively low, this kind of sustained increase in the rate has in the past preceded recessions. However, this has usually come about when the absolute level of job creation is lower than it is today. Schroders’ US economist also notes that rising unemployment has not been driven by layoffs, but rather by elevated inward migration outpacing job creation.
The employment data that has sparked concern
US non-farm payrolls, 3-month average (thousands of jobs)
Source: LSEG Workspace, September 2024.
Still, the slowdown in the US employment market is noteworthy. The US consumer is a huge part of both the US and global economy and a reduction in spending would have a negative impact on corporate profits and economic activity around the world.
We think that there has been some overreaction in markets. Other data still paint a relatively healthy picture of the US economy. Retail sales, for example, have remained very strong despite the rise in unemployment. Households are also benefiting from lower inflation and strong balance sheets, which should help them withstand a slightly weaker economy.
US wages are rising in real terms
Real US wage growth, year-on-year %
Source: Schroders.
Most importantly, the steady fall in inflation that we have seen over the past 18 months means that the Federal Reserve now has clear scope to cut interest rates. It started the process at its September meeting, with a 0.5% rate cut. Interest rates are still high compared to where they have been over the past decade, but the fact that they are moving lower should support growth.
Our view remains that the US economy will cool but continue expanding at a reasonable pace over the remainder of 2024 and into 2025. This environment should be supportive for equities and other risky assets.
How far and how fast will US interest rates fall?
Following the Federal Reserve’s latest interest rate decision, bond markets are pricing in US interest rates falling towards 3% by the end of 2025. Not everyone agrees. Schroders’ economists think that the Fed will move more cautiously, with US interest rates falling more slowly.
We are in a similar position to the end of 2023, when markets expected as many as seven interest rate cuts in 2024. We think the more extreme scenario for 2025 would only come to pass if the US fell into recession, which is not our base case today.
The risk is that cutting interest rates too far or too quickly could boost demand and cause inflation to rise again. The Fed and other central banks are keen to avoid this. They could be forced to raise interest rates again, destabilising equity and bond markets as in 2022. And their credibility would be undermined, making it harder to gain the trust of consumers and investors in future.
Getting the balance right will be hard. Central bankers have imperfect information on how the economy is performing. And just as interest rate rises took far longer to impact the economy than expected, they don’t know exactly how long it will take for cuts to have a benefit. So there will be more uncertainty – and volatility – along the way.
Change of market leadership?
In the first half of the year, the performance of global stock markets was led by the Magnificent 7, the largest US tech stocks. This has no longer been true since the summer. From the end of June, the other 493 stocks in the S&P500 have outperformed the technology giants. This is a healthy development, as a rally based on the outperformance of a very small group of stocks is less likely to be sustainable. A broader rally also creates more scope for active stock pickers to outperform.
There are several reasons behind the shift. Lower interest rates are of more benefit to medium-sized businesses than the cash-rich technology giants. And while investors remain broadly enthusiastic about the long-term prospects for artificial intelligence, there is now more scepticism about the level of demand and pace of adoption, at a time when US technology firms are investing massively in the new technology. There are also signs that the regulatory backdrop is becoming more difficult, with Alphabet currently on trial for its alleged monopoly of online advertising.
What about the rest of the world?
The new UK government has faced criticism for its early focus on tax increases and employment rights - rather than growth. Even so, economic data coming out of the UK has generally been better than forecast. Reduced uncertainty following the election, as well as lower inflation and interest rates, may already be benefiting consumers.
There is finally more encouraging news coming out of China, following a significant stimulus package led by the country’s central bank. In an unusually wide-ranging set of measures, policymakers cut the benchmark policy interest rate, lowered bank reserve requirements and launched new financing facilities to support stock markets. The announcement prompted the best week for Chinese equities since 2008, as investors rushed back into a very unloved market. However, the response in other markets exposed to Chinese activity has been less dramatic. This suggests there is still some doubt about whether the stimulus package will sustainably boost growth or if further fiscal measures are needed.
US election
Kamala Harris is proving far more appealing to US voters than Joe Biden in the race against Donald Trump.
Polling in the key swing states, which will determine the outcome of the election, have moved in her favour in recent months, but the outcome is still too close to call. Her success in the debate with Donald Trump, and endorsement by Taylor Swift, both added to the momentum as far as the media were concerned, although the bump in the subsequent polling was hard to discern.
From an economic perspective, a Harris victory may not significantly change the outlook, given her support for many of Joe Biden’s policies and the likelihood that she will have to contend with a divided legislature. A Trump victory could prompt a more significant shift. His focus on tax cuts and deregulation could mean growth is slightly higher than under Harris, but the promise of tariffs and antiimmigration policies may also lead to higher inflation.
Neither candidate has provided much reassurance on US government debt, which is seen by many commentators to be on an unsustainable path. Both will be counting on the continued quiescence of the bond vigilantes.
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