Because the summer will bring us the rate cut
Immaculate disinflation will lead to rate cuts over the summer. Analysis by Steven Bell, Chief Economist EMEA of Columbia Threadneedle Investments
The economies of the United States, Europe and the United Kingdom will hold the promise of immaculate disinflation. The turnaround of the US economy, which began last year, has been the most significant, while the British and European economies have entered a phase of stagnation. Yet, inflation has fallen across developed economies, with wage growth following the same trend, although there has been no increase in unemployment, not even during the “technical recession” in the UK. The low level of unemployment has allowed pressure on central banks to be eased with respect to an immediate rate cut. Therefore, we see clear signs that wage inflation may soon return to central banks' targets. For these reasons, we expect interest rate cuts to be larger than what the market is currently anticipating.
Consensus estimates for the British economy are still too pessimistic
We believe the UK will face a significant, if unspectacular, recovery phase. Currently, the country is experiencing rapid year-on-year wage growth, with a 9.8% increase in the minimum wage.
While this may pose a problem for inflation and the BoE, consumer price inflation is reaching the central bank's target and is expected to remain there for the next twelve months; furthermore, inflation is likely to fall well below the 2% target in the coming months. With wage growth exceeding falling inflation, real incomes will receive a much-needed boost. Given this, British consumers could easily increase their spending further if they reduced their savings levels from current peaks.
Furthermore, it is possible to observe the impact of these positive factors on the drastic turnaround of the British property market. In fact, if we initially expected a decline in house prices of 10%, from peak to trough, we now see that the market has only fallen by 5% and we expect the losses to reverse by the end of the year.
The fall in inflation will give impetus to real wages and allow interest rates to be reduced in Europe too
The contraction of the German economy, particularly its manufacturing industry, does not negatively affect the strength of the overall European economy. In fact, looking elsewhere, such as in Spain, consumption has shown much more positive dynamics. Although wage growth is currently too high, it is likely that, following the spring wage negotiations, there will be a sharp reduction, which will put the ECB in a position to cut rates in June. These wage increases, especially when compared to falling inflation and energy bills, will support a recovery in real incomes after a challenging period for consumers. Consumer spending could easily translate into further gains in purchasing power if growing confidence allows consumers to spend some of their accumulated savings.
Furthermore, the elections scheduled for this year represent an important variable for investors. If for the United States the outcomes of the presidential and Senate races are still very uncertain, as far as the elections in the United Kingdom are concerned, the big favorites are the Labor Party. Falling inflation and lower interest rates will support both bond and stock returns; the latter, in particular, will also benefit from the boost to economic growth provided by the rate cuts themselves. However, relative valuations are currently in favor of bonds.
The US economy loses momentum but remains on track
During 2023, the US economy surprised positively; however, we expect less consistent growth in 2024. In fact, since the "Covid-19 piggy banks" have now run out, US consumers will not be able to sustain future growth in spending, which will likely be lower than that in profits given the gradual replenishment of savings.
US inflation, which has already shown a sharp decline, may now fall more slowly, as the tightness of the rental market accounts for a large part of the consumer price index compared to the more modest (and realistic) weighting in the UK and in the Eurozone. The economy's loss of momentum on the other side should drive lower hiring and wage inflation, giving the Fed enough reason to begin the cycle of rate cuts.
We believe the risk of recession is minimal as wage increases remain above the decline in consumer inflation, providing US consumers with increased real income. Financial conditions have eased and rate cuts should further support confidence.
Lower interest rates make both bonds and stocks attractive
Resilient growth, declining inflation and lower interest rates create a favorable environment for investment returns. In this regard, we are bullish on stocks and bonds, with a slight preference for bonds due to relative valuations. The latter, in fact, suggest an increase in the share price over the next twelve months.
In the case of US stocks, this valuation gap is primarily due to the dynamics linked to the "Magnificent Seven", which drove the expansion of margins and profits, while the rest of the S&P 500 index suffered a sharp decline. However, not all Magnificent Seven appear equally “magnificent”: we prefer the strong earnings growth resulting from the evolution of the artificial intelligence market. Gold has also suffered a valuation gap: the price has risen despite rising interest rates which would normally reduce its attractiveness.
After the freezing of Russian foreign currency reserves and the assets of approximately 2,000 people and related entities, we see a fundamental shift in demand. The recent decision to allocate the interest of some accounts to the reconstruction of Ukraine confirms the changing nature of “safe” assets and should benefit the yellow metal again.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/estate-taglio-tassi/ on Sun, 14 Apr 2024 06:20:06 +0000.