“Any shock that will exacerbate stagflation pressure such as a non-disinflationary recession…or a surge in the price of raw materials, will prevent rate cuts by the central banks,” warned Didier Borowski, head of macro policy research at the Amundi Investment Institute during an interview in Luxembourg on 8 November 2023. It is rather a risk scenario as he considers that it is more reasonable to expect disinflationary pressure to carry on, leading to rate cuts in 2024.
Not all geopolitical events are created equal
Borowski commented that the energy crisis in Europe and the effect on inflation that followed Russia’s invasion of Ukraine demonstrated that some geopolitical events are impactful on economies and financial markets. Yet he thinks that the conflict in Gaza will remain local. He noted that oil prices came back below the level seen before the events on 7 October in Israel.
The excess saving is an endangered species, though… and the US economy will not be further supported by these effects in 2024
However, an enlargement of the conflict, a war premium, or a disruption of the current oil price equilibrium--which he assessed at between $85 and $90--by oil producers may result into oil prices moving up to $95. Separately, he takes comfort that gas inventories are replenished in Europe, limiting shocks on prices.
US GDP at 4.9% in Q3. It should not last
Borowski opined that the Inflation Reduction Act and the Chips and Science Act in the US underpinned the non-residential investments which supported growth in Q1 and Q2. Growth was boosted in Q3 by consumer spending, excess savings and a vigorous labour market over the year. But more importantly, in the third quarter, excess savings had a greater impact on consumption than expected.
“Everyone was surprised by the economic impact of these stimulus including the US Treasury, the Fed and the IMF, resulting in the rare revision of the GDP forecast for 2023 last summer,” commented Borowski.
“The excess saving is an endangered species, though… and the US economy will not be further supported by these effects in 2024,” stated Borowski. “These were an illusion of resilience.” In addition, the economy is confronted with the tightening of credit conditions through higher interest rates on credit cards and mortgages, as well as for SMEs.
Consequently, Amundi expects a significant slowdown in Q4 (from 4.9% to 1.0%) and a “small recession (less than minus 0.5%) in the first two quarters of next year… which should reduce demand-side inflation pressure.” He stressed that this is currently not expected by the market.
Pressure on the long end of the curve, or not?
Borowski noted the “very elevated” deficit in the US despite its growth. Contrary to Europe, he expects that debt-to-GDP will continue to rise. The absence of the Fed and the lesser appetite by large sovereign wealth funds around the world, including China’s, will add pressure on bond prices (i.e., higher yield).
The recession alone is a not a condition sine qua non for cutting rates. It must be coupled with the maintenance of a disinflationary trend… several months in a row
Yet he expects a normalisation of term premiums for treasuries, which is largely reflected in the current rate for the 10-year treasuries (4.50%) when considering a growth potential of 1.8%-2.0% and inflation to hover around 2%-3%.
It will not therefore come as a surprise that Borowski expects 10-year treasuries to go down to 4% in the next six months on the back of a small recession and less purchases by foreign investors. He completely ruled out the low level of rates (2%-3%) experienced before the recent bout of inflation.
Recession and disinflation: a cocktail for rate cuts under certain conditions
“Should we see a shallow recession early next year with disinflation pressure, the Fed may cut rates by 150bps in 2024, starting in May,” said Borowski. Moreover, he expects growth to be largely flat for the full year. Amundi is clearly an outlier as the market is barely starting to price-in a cut in Fed rates next year.
“The recession alone is a not a condition sine qua non for cutting rates. It must be coupled with the maintenance of a disinflationary trend… several months in a row,” said Borowski. He does not see rate cuts as accommodative but rather to avoid tighter monetary conditions.
High or even higher rates are prone to what type of accident?
Higher rates have a lag effect on economic stakeholders. He expects that the largest impact will be on private and public entities with the greatest indebtedness. More precisely, Borowski is concerned about higher default rates on the non-investment grade asset class despite a refinancing wall only in 2025 and 2026.
He thinks that main difference between the monetary normalisation in the 1970s and now is the current level of debt. Consequently, “the probability of financial accident has increased,” as observed with Silicon Valley Bank earlier this year.
GDP in the eurozone: will consumers draw into their excess savings in 2024?
Q3 GDP fell 0.1% in the eurozone, dragged down by Germany (-0.1%), no growth in Italy but partially offset by France (0.1%) and Spain (0.3%). As for the poll of economists conducted by Reuters on GDP expectations for 2024 (0.0%), Borowski does not expect a much better picture in Q4. “Growth has been flat (0.1%) over the last 12 months whereas it was 2.9% in the US.”
He thinks that Europe was more sensitive to the energy shock, experienced low consumer confidence and a high saving rate on the back of the geopolitical situation. The US spending its excess savings is the main reason for growth difference between the two blocks.
Yet pent-up demand is building up. He commented that salaries are increasing by around 4% this year, resulting into real growth in revenues and higher spending should disinflation continue. “Only about 30% of the NextGenerationEU fund have been invested so far,” said Borowski. There is hope for an acceleration of capital spending over the next two years, but its impact is not a “game changer.” Despite these positive technical factors, growth should stay around flat again in the eurozone in 2024 and he does not expect a recession.
ECB to cut rates by 75bps in 2024
The European Central Bank will not stay on the sideline either, per Borowski. He expects the ECB to cut rates by 75bps in 2024 as inflation will also further abate, but not as quickly as in the US. The ECB will likely be reactive and not proactive.
As salary inflation will stay high without improvement in productivity in the upcoming quarters, the core inflation rate will likely stay elevated, he forecast. It is still at a level above 4%, whereas total inflation has continued to decline. The stickiness of core inflation may also refrain from cutting rates as early as in the US. Yet he expects cuts as early as June or early summer.
Cash: will the king be dethroned in 2024?
“Cash is on waiting mode,” said Borowski. Given the widespread uncertainty on geopolitics and the recession risk, cash and government bonds remain for now his preferred financial products. More specifically, “the cycle will initiate [early] next year a bull-steepening move on the US yield curve,” with the front end declining faster than the long end.
“It is not cash forever”
“It is currently not the time to jump into equities… the trigger point [for buying stocks] will likely be the pivot and the size of the expected rate cuts by of the Fed. Furthermore, positive statements by central banks will likely result in further strategic reallocation into equities--small caps in particular--later in 2024.
On a final note, Borowski expects growth to revert back to its potential in the US (around 2.0%) and in Europe in 2025. No rate forecasts were provided for 2025.
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link.