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Macroeconomic Conditions

The US economy shines amidst global challenges, but 2024 might tell a different story. Canada shows signs of strain, Europe flirts with recession, and China's consumer boom contrasts its property woes. Inflation concerns persist globally. How will central banks react?

The US economy continues to perform much better than expected with strong consumer spending and high fiscal spending on construction projects associated with onshoring manufacturing capacity as part of the Inflation Reduction Act.  

H1 Real GDP annualized growth was upwardly revised to 2.2% and is poised to accelerate at a much faster pace in Q3 according to GDPNow models.   Consumer spending remains high, employment remains strong, fiscal spending on a variety of infrastructure project initiatives remains robust, and there are even nascent signs of improving manufacturing data with industrial production growth at the highest level since October 2018. 

Most economists expect Real GDP to slow substantially in 2024 to 1.0% from 2.3% in 2023 as excess consumer savings bleed down, wage growth slows, bank lending slows, and unemployment ticks up modestly.   However, analysts have consistently underestimated the strength of the US economy since the pandemic.   

Canada’s economy likely rebounded from the modest contraction in Q2, but trends are showing signs of weakness.

Employment continues to weaken more than expected with the unemployment rate increasing by 0.5% over the past four months (slower hiring relative to surging population and labor supply growth).  Consumer spending flattened and business investment has slowed as well.

The slowing economy coupled with declining core inflation makes it likely that the Canadian Central Bank will not raise interest rates further.

Europe’s economy is under pressure with Germany, Spain, France, and Italy all flirting with recession.

Bank lending and money supply are declining, reflecting the impact from the ECB’s rate hikes.

Manufacturing remains weak with PMI surveys near 43 (well below the 50-level which indicates neither growth or contraction).   Worryingly, services PMIs have also breached 50, indicating that services may no longer buoy Europe’s economy.

China’s economic growth accelerated from Q2 driven by strong consumer spending.

GDP accelerated to 1.3% Q/Q, up from 0.9% in Q2.  Retails sales increased by 5.5% YOY in September, the fastest pace in five months.

The property market remains extremely weak despite various measures of government support.   

The largest property development company, Evergrande, recently filed for bankruptcy and the country’s largest homebuilder appears close to defaulting.  

Government stimulus is expected to increase in Q4 2023 and into 2024 which should help reinvigorate growth.  In addition, to monetary stimulus, the government is weighing lending directly to local governments.   Also, the government is considering strengthening fiscal stimulus aimed at increasing domestic consumption.    

Inflation has clearly peaked across most major economies with both headline and core inflation down meaningfully from 2022 highs.  

However, core inflation remains well above central bank targets.  In the US, core inflation was 4.1% YOY in September and 0.3% MOM (an increase from previous months of 0.2%).   Services inflation remains sticky, and recent oil price increases have led to increases in producer prices paid (which can be harbingers for future increases in core CPI).   

On a positive note, wage growth has slowed considerably in the US despite the labor market remaining very strong.  

Most analysts agree that the rate hiking cycle has either been completed or is very close to completion across most central banks.   Rather the debate centers around: a) when do central banks start cutting rates and what is the magnitude of those rate cuts and b) what happens to yield curves and rates for longer-dated maturities?

We believe that the Fed is more likely to hold the Fed-funds rate higher for longer as the US economy appears robust (as of 10/10/23).

Other central banks (ECB) may be more inclined to cut rates faster if economic weakness persists or intensifies.

While we acknowledge a wide range of possible outcomes, our current thinking is for Fed rate cuts of 50bps-75bps and a decline in 10-year US Treasury yields to 3.50%-3.75% from 4.6% today.

The recent sharp rise in longer-term bond yields should tighten financial conditions and help slow the economy which should further reduce inflation.  

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