Amidst a climate of heightened confidence, risk assets are rallying, underpinned by a broader improvement in global economic sentiment.
Investors are increasingly optimistic that policymakers will orchestrate a soft landing, a sentiment that gains support from recent economic data releases.
Market sentiment has solidified in recent months, driven by resilient US consumption, marginally more positive Chinese activity data, and glimpses of optimism in the latest sentiment surveys across Europe. Crucially, global inflationary pressures are abating, and tight labour market conditions are showing signs of moderation.
Within this global context, Australia’s outlook is less clear. The domestic economy is experiencing a declining growth rate, buoyed by very high immigration rates, alongside easing but relatively sticky inflation, with a still tight labour market. This suggests an extended period of “on-hold” rates through 2024. This stands in contrast to the recent trends observed globally, where there is an encouraging deceleration in inflation, and significantly greater confidence that policy rates have reached their peak.
We expect the global inflation pulse to continue fading over coming months as the market’s attention pivots from inflation concerns to a sharper focus on growth, labour market dynamics and central bank easing in 2024. The soft landing narrative (our base case) will still likely face challenges, as factors that have contributed to the unexpectedly resilient economy this year are expected to fade throughout 2024.
The US economy has surprised with its resilience this year, defying consensus expectations of a 2023 second-half recession. Resilience has been a function of excess savings and a historically tight labour market, which has supported robust consumer spending levels. Recent data remains consistent with a soft-landing, as inflationary pressures are abating, and tight labour market conditions are showing signs of moderation. Against this backdrop, the market has firmed up its view of no further hikes and is pricing a total of 100 basis points (bps) of cuts into 2024.
A larger-than-expected slowdown in the US economy looms as arguably the greatest risk for 2024. We do not see this as an imminent threat over the next few months due to the quite gradual cooling in economic activity currently playing out.
On the inflation front, the US consumer price index (CPI) has shown the capacity to bounce around the declining trend. However, we have reasonably high confidence that inflation will continue to ease on a 3- to 6-month view. If the US economy can stay on this path of decelerating inflation while avoiding a recession, the outlook should be positive for US equities and fixed income.
We believe the odds are still tilted towards a US soft landing, although the risk of recession appears higher in 2024 than in 2023. We are watching the labour market and consumer stress for cracks in the soft-landing scenario.
The anticipated ongoing deceleration in US inflation throughout 2024 should allow the Fed to concentrate its reaction function predominantly on the labour market. The size and speed of a labour market softening is what will ultimately drive the trajectory of the Fed easing cycle next year, in our view.
Key signposts for the US over coming months will be employment data, with a focus on more frequent and alternative data like payrolls, jobless claims, job listings and hiring surveys, which should give a timelier edge on an impending slowdown in employment.
The first negative payrolls print is typically a warning signal as shown on Figure 6. We expect payroll growth to persist in the upcoming months before gradually tapering to a marginally below pre-pandemic monthly average pace of ~170k. A reduction in the breadth of payroll gains could signify a weakening underlying trend, so we are watching if the pullback in hiring is broad-based.
• Monitoring the breadth of payroll gains across industries and the speed of the decline towards average pre-pandemic monthly pace.
• A reduction in the breadth of payroll gains signifies a weakening underlying trend, the first negative payroll print is a recession warning signal.
|Initial Weekly Jobless Claims
• Initial jobless claims provide a timely and high-frequency indicator of the state of the US labour market.
• Higher than expected number of initial jobless claims suggest the labour market is weakening and many workers are facing hardship due to layoffs.
|ISM PMI Survey Employment Components
• The ISM PMI survey employment components tend to have a positive correlation with the nonfarm payrolls report, they provide insights into manufacturing and service sector hiring intentions.
• Readings below 50 indicate employment is contracting.
|Indeed Job Listings
• Watching if the deceleration extends across industries, 50% of industries exhibiting diminished job demand compared to long-term levels serves as a crucial benchmark.
|Job openings and quit rates
• Job openings and quits can help assess the tightness or slackness of the labor market, as well as the availability and quality of jobs.
• A declining trend in job openings indicates waning labour demand, this series tends to lead the unemployment rate.
• Declining quits indicate workers have less bargaining power, this series coincides with consumer confidence.
Source: Refinitiv, Wilsons Advisory.
|Lead time (months)
|9 months late
|3 months late
|1 month late
Source: Refinitiv, Wilsons Advisory.
While the US consumer has demonstrated resilience, the tailwinds that fuelled spending growth in 2023 are now fading. Excess household savings are expected to be depleted within the next few months. Some stabilization is expected following rising real wage growth, although rising mortgage refinancing bills, recommencement of student loan repayments, tighter credit conditions and a slight deterioration in job security will cap willingness to spend.
Given the US consumer is one of the most important drivers of global economic activity, consumer confidence surveys and spending data will be key signposts to watch in 2024 to gauge the extent of the slowdown.
The Australian economy has weathered the rise in policy rates so far, and the labour market remains resilient, but we expect real gross domestic product (GDP) to slow further to ~1-2% in 2024. GDP will be dragged down by rate hikes but aided by strong population growth, which at the same time is contributing to the current sticky inflation problem, most obviously through the housing channel but also by adding to general economic demand.
A domestic hard landing remains a “risk case,” not our central case. The more recent activity data indicates the economy is softening, but not falling into recession. Meanwhile, the labour market has moderated over recent months, with a slower pace of employment and hours worked. The easing of the tightness is still only relatively modest, as the unemployment rate remains near a 50-year low at 3.6%.
While a number of the world’s major central banks have hit the policy pause button in recent weeks, the more stubborn domestic inflation backdrop forced the Reserve Bank of Australia’s (RBA) hand in the recent November meeting. Notably, the above-consensus readings for headline, underlying inflation and wages in the September quarter suggest domestic inflation remains sticky.
Despite the better-than-expected monthly print for October, the possibility of another hike early next year cannot be completely ruled out. Markets imply a ~40% chance of one further hike to 4.60% in the first quarter of next year.
Fourth quarter CPI (due January 31, 2024) will be the key data signpost that will determine whether the upside surprise in the third quarter has persisted. The fourth quarter wage report (due February 21, 2024) will also be a key release.
We see the RBA keeping rates 'higher-for-longer', before commencing a modest easing cycle, with the first rate cut currently pencilled in for November/ December 2024.
Contrary to expectations, Europe surprised to the upside in early 2023, narrowly avoiding a recession, aided by falling energy prices. Recent economic data has beaten consensus expectations, with both consumer and business confidence indicators showing an upturn. The better-than-expected inflation data has further fuelled optimism, raising hopes that policy rates have peaked and that the European Central Bank (ECB) is on track to ease by mid-2024.
Much of the inflation pulse in Europe has been driven by the second-round effects of last year’s big increases in oil and gas prices. Energy inflation has flipped from a high of close to 50% early last year to -11% in the 12 months to October 2023. The energy price outlook will remain important as we approach the European winter. Our base case is that Europe should narrowly avoid recession in 2024, although growth will be lackluster.
Although the Chinese economy – a key driver of the European industrial sector - is not rebounding meaningfully, it is stabilizing which eases headwinds for the Euro Area.
In contrast to an upbeat consensus at the start of the year, China has proven to be the biggest disappointment in respect of the global economy for 2023, weighed down by property weakness and low consumer confidence. However, growth momentum has improved marginally in recent months, as policymakers have pivoted toward growth-stabilization mode and recent activity data has come in ahead of expectations.
Looking forward, we expect GDP growth to continue to be modest (~4-5%) with policy support and a consumption recovery countering lackluster property conditions. The prospect of property activity not stabilizing poses a large downside risk in 2024, although we expect new property starts and sales will stabilize and improve modestly through 2024, with the help of ongoing policy easing. It will be key to monitor household confidence, home prices, private business investment and hiring. Positive developments on these fronts could offer some reprieve to beaten-down investor sentiment, which, in our view, has become excessively pessimistic.
Still, there are no signs that policymakers are about to provide “big bang” stimulus, meaning the trajectory of the global economy will be driven by the trend in the developed world, as it was this year, With the Fed and the US$ likely to be the stronger catalysts for an Emerging Market re-rating than China in 2024.
Improved sentiment around global inflation, cooling growth and the policy cycle will be the key to further gains in risk assets in the new year.
We expect the global inflation pulse to continue fading over coming months, as the market’s attention pivots from inflation concerns to a sharper focus on growth, labour market dynamics and central bank easing in 2024.
We believe the odds are still tilted towards a US soft landing, although the risk of recession appears higher in 2024 than in 2023. We are watching the labour market and consumer stress for cracks in the soft landing scenario.
We expect US growth to slow (but not collapse) over coming quarters. Inflation should also continue to ease over the coming 12 months. This should be a reasonably supportive backdrop for both stocks and bonds, all things equal.
Inflation still remains central to the domestic outlook. The Australian economy should continue to grow in 2024, albeit at a below-trend pace, aided by strong population growth, which at the same time is contributing to the current sticky inflation problem and is clearly making the RBA’s job more difficult.
Disinflationary global trends will likely provide some upside pressure, while a higher-for-longer domestic cash rate will create headwinds. Nonetheless, a domestic hard landing remains a “risk case,” not our central case. The current 4.35% cash rate likely represents the peak for the cycle, however, the prospect of RBA easing appears to be a late 2024 story in our view.
David is one of Australia’s leading investment strategists.
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