Executive summary:
- We think it's more likely than not that the U.S. avoids a recession in 2024, but economic uncertainty remains high with the economy running at full capacity, household savings diminishing, the labor market slowing down, and the U.S. Treasury yield curve still inverted.
- The U.S. Federal Reserve, the European Central Bank and the Bank of Canada could begin cutting rates by June. We think the Bank of England and the Reserve Bank of Australia may follow suit in the third quarter of the year.
- Amid an uncertain economic outlook, we're emphasizing the importance of security selection and diversification as the second quarter unfolds.
We believe optimism over a soft-landing scenario—where economic growth slows but a recession is avoided—may deliver more near-term market gains, as inflation declines and central banks look to start easing around mid-year. However, we think the risks of a sharper economic slowdown later in 2024 are elevated, as the lagged impact of previous interest rate rises has yet to be fully felt.
Key market theme
Raphael Bostic, president of the U.S. Federal Reserve Bank of Atlanta, coined the phrase pent-up exuberance in a recent speech. While Bostic was referring to the risk of renewed economic acceleration, we believe the term also captures the mood of markets, as exuberance about the surprising robustness of the economy spills over into investor enthusiasm. Coupled with declining inflation and solid corporate profits—particularly for AI (artificial intelligence)-themed mega-cap stocks—investors who were fearful of a recession in 2023 are being drawn into the market, with the positive momentum having the potential to push the S&P 500® Index to further record highs.
While a soft landing is possible, we think the risks of economic growth eventually disappointing markets are underappreciated. President Bostic's warning of pent-up exuberance is one that we believe investors should carefully consider, as this year's optimism could eventually prove to be excessive.
We still think some of the impacts of the Federal Reserve's (Fed) aggressive rate-tightening campaign are continuing to work their way through the U.S. economy—just at a slower pace than usual. Our concern is that the Fed's caution about inflation being sticky will further delay rate cuts. In our opinion, this increases the likelihood that the soft landing currently priced by markets overshoots into a mild recession. We expect the Fed to start easing in the middle of the year, but will become more concerned about the longer-term outlook if rate cuts are delayed to the end of the year.
We believe it's more likely than not that the U.S. avoids a recession in 2024, but economic uncertainty remains high with the economy running at full capacity, household savings diminishing, the labor market slowing down, and the U.S. Treasury yield curve still inverted.
In Europe, economic activity indicators are surprising to the upside, while core inflation is tracking toward the European Central Bank's (ECB) 2% target. The ECB has hinted that rate cuts are likely to commence in June in response to the downward trend in core inflation.
The outlook for the UK continues to be challenging. GDP (gross domestic product) growth is stagnant, and inflation is declining at a slower pace than in other developed economies. Market expectations are for the Bank of England to begin lowering interest rates in the third quarter, which would provide some relief.
China has announced a 2024 GDP growth target of around 5%. Unlike last year, its economy will not benefit from a post-pandemic reopening, which leads us to believe that this target will be difficult to achieve.
Japan is beating expectations in economic activity and corporate profits growth, as well as in financial markets, where the Tokyo Stock Price Index (TOPIX) has reflected the best performing market year-to-date. We anticipate trend-like growth from Japan through the rest of the year.
We expect the Australian economy to continue with below-trend growth, but think a recession will be avoided. The Reserve Bank of Australia will likely lag other central banks in cutting rates, and we expect the first rate cut at the end of the third quarter.
In Canada, we believe a recession is more likely than not over the next 12 to 18 months, with the Bank of Canada likely to start cutting rates by mid-year.
Economic views
- U.S. inflation
We think 2%-2.5% inflation is in store for the end of 2024. This should allow the Fed to start gradually transitioning policy back to a more normal setting around mid-year. - Bank of Japan policy
Wage growth and inflation expectations have moved toward levels that are consistent with the Bank of Japan's (BoJ) inflation target. We believe this should allow the BoJ to normalize policy slowly through 2024. - European resilience
We believe that the recovery in bank lending in Europe suggests that the region's positive economic momentum can be maintained over the next quarter. - China stimulus
From our vantage point, China's 5% GDP growth target for 2024 suggests that more meaningful policy moves will be forthcoming. - Bank of England (BoE) easing
Fixed income markets expect the BoE to deliver two to three 25-basis-point rate cuts this year. This seems like an underestimate to us, given the underlying weakness of the UK economy.
Asset class views
Equities: Neutral
The equity market outlook appears constrained by expensive valuation multiples, optimistic industry-consensus earnings growth expectations, and overbought sentiment. Our portfolio strategies are neutral across major equity regions. While non-U.S. developed equities still trade at a steep discount to U.S. equities, we think there is significant uncertainty around the ability for these markets to deliver differentiated earnings.
Fixed income: Government bonds provide attractive value
We believe government bonds offer attractive value for investors, as yields still trade well in excess of expected inflation. U.S. Treasuries are a preferred overweight exposure for us, as we see particularly good value in the five-year point of the yield curve. We also see potential for the curve to re-steepen if more aggressive rate cuts are delivered in the next few years.
Currencies: Neutral stance on U.S. dollar
The U.S. dollar is expensive, which suggests potential for the greenback to decline over the medium-term. However, the potential for a global recession in 2024 could result in further upside for the dollar in the short-term as investors flock to the relative safety of U.S. assets. We believe these two-sided risks warrant a neutral stance.