A maintenance worker sweeps the street in front of a row of new homes in Fairfax, Virginia, on August 22. Sales of homes in the United States fell in July as elevated mortgage rates and limited housing supply held buyers back. Photo: AFP
Opinion
Macroscope
by Chris Iggo
Macroscope
by Chris Iggo
How to lift global economic gloom and restore investors’ faith in recovery
The belief in a soft landing for the global economy is not widespread and, as a result, participation in the strong equity market performance has been limited
Halting interest rate rises, an improved global growth outlook, and an end to the war in Ukraine would help ease investor concerns
Markets have gone through something of a correction this month. The best-performing equities this year have delivered losses over the summer. Asian bourses and growth sectors like technology have been hit, with positive performances only seen in more defensive, higher-quality indices such as the Dow Jones Industrial Average.
On the bond side, despite better news on inflation and more evidence that we are at the peak of the global interest rate cycle, most fixed-income sectors have delivered a negative return over the past month. Long-duration strategies – those betting that long-term bond yields will fall – have underperformed.
There is frustration everywhere. The belief in a soft landing for the global economy is not widespread and, as a result, participation in the strong equity market performance has been limited this year. Investors and businesses have been more aligned with recession fears.
What could change this sentiment and make things less frustrating? First is a signal from central banks that rate rises are at an end. This requires further falls in inflation in the US and Europe. Only then would investing in something other than cash become more enticing. Market expectations are for interest rates to start coming down in 2024.
The soft-landing scenario suggests that interest rates could stay elevated for some time, even if there are no more increases. However, some monetary policy easing is likely in 2024 in the US, Europe and elsewhere as global inflation slows and the effects of monetary tightening flow through to reduced borrowing.
Second is the growth outlook. The global economy has performed better than expected this year and recessions risks have declined. A soft landing for the US economy is not such a fanciful outcome any more. Economists have underestimated the resilience of consumers, even with increased living costs and higher interest rates.
Having dealt with the shock of the Covid-19 pandemic, companies and households have emerged stronger overall with better-managed balance sheets and financial reserves. Firms are also more reticent to lay off workers than previously, knowing that rehiring is more difficult. Moreover, the opportunities to use artificial intelligence to improve productivity are boosting corporate spending.
If major economies do avoid a recession or see only a modest slowdown, and that becomes more of a consensus view, financial markets should reflect that. After coping with the pandemic, an inflation shock and higher interest rates, it seems that a soft landing is the more likely outcome for major economies than a deep recession.
A woman walks past the Shanghai Stock Exchange building on August 21. Markets have faced a setback as China’s reduction in lending rates proved to be smaller than anticipated. This extends Beijing’s trend of implementing more-conservative stimulus measures than expected. Photo: EPA-EFE
Globally, the outlook for China is important. Growth has disappointed since the country’s reopening as Chinese consumers and businesses were hit harder during the pandemic than elsewhere. The property market remains a drag on growth and confidence is lacking.
Better news from China would help sentiment. Government policy decisions would be a key source of improved economic strength. Emerging markets in general would benefit from financial vulnerabilities being addressed.
Sino-US relations are also key. A full reversal of US restrictions on investment in certain Chinese sectors is unlikely. However, ahead of the 2024 US presidential election, more constructive dialogue would be welcome. China’s business cycle prospects need better trade relations with Western economies. Anything that points to improved trade flows and investment cooperation would help raise optimism.
Finally, an end to Russia’s invasion of Ukraine would trigger positive market developments. More stability in commodity markets would reduce the risk of another global inflation shock. It would also take the pressure off European governments to drastically increase defence spending. The reconstruction efforts that would follow an end to the conflict would also provide significant investment opportunities.
04:15
Russia’s rouble falls to lowest value against US dollar since Ukraine war began
Russia’s rouble falls to lowest value against US dollar since Ukraine war began
A lack of any of the above happening could mean continued frustration for investors and economies. Short-term interest rates could remain high well into 2024 if inflation stays above central banks’ long-term targets.
We will not be returning to the kind of yields that prevailed in the decade before 2022, and this sets a higher benchmark for returns across asset classes. Commodity markets could remain volatile, leaving a higher inflation risk premium in place. Recent volatility in some emerging markets could also add to the conservatism.
Short term, the interest rate outlook could remain the source of market underperformance. The gathering this week of central bankers in Jackson Hole, Wyoming, will give some insight into why interest rates might remain elevated, at least through to the end of this year.
The technology sector may be the only place for long-term growth opportunities. Geopolitically-driven protectionism would suggest that US technology companies will continue to trade on high valuations as investors see them as the best way to benefit from growth in AI.
Chris Iggo is chair of AXA Investment Managers Investment Institute and chief investment officer of AXA IM Core
