Reality check for the market outlook

The week leading up to Christmas was eventful. Important economic data was published and numerous central bank meetings took place. This provides an opportunity to subject the annual outlooks, some of which were published in November, to a reality check.

The investor community seems to be largely united in its expectations for the coming year :

• The economy in the developed economies should continue to grow in line with the trend (slightly below 2%).
• Inflation remains slightly above 2% (national average).
• Corporate profit growth remains high.
• Neither monetary nor fiscal policy will dampen economic growth. This means that finance ministers will not pursue an austerity policy and central banks will not raise key interest rates sharply to curb inflation.
• The trade conflict between the USA and the “rest” of the world should take a back seat.
• There are no significant fears on the part of investors with regard to the high government debt ratios.

The risk scenarios are therefore almost self-evident. On the negative side, economic growth or the labor market and / or earnings growth could disappoint. Concerns could also arise regarding the independence of central banks and statistical authorities.

However, it could easily be the case that we have been looking in the wrong direction for years: namely at the downside risks. On the positive side, economic growth could not only remain resilient to negative developments, but could even increase. This would be conceivable if, among other things, the AI boom continues and is reflected in the real economy in the form of higher investment and productivity growth.

Downside risks at a glance

The majority of this week’s reports on economic growth pointed to the downside risks to growth. Firstly, indicators on the US labor market showed a further rise in the unemployment rate (November: 4.6%, low in April 2023: 3.4%) and de facto stagnation in private sector employment.

Secondly, the preliminary purchasing managers’ indices for December pointed to downside risks, as key leading indicators such as new orders fell significantly. In Germany, the Ifo Institute reported that the year is ending without a sense of optimism. On a positive note, however, negative news is needed to ensure that there are positive surprises next year, i.e. that the “resilience” scenario holds.

Inflation slowly declining

On the inflation side, the indicators are pointing sideways to lower. In the eurozone, consumer price inflation remained unchanged at 2.1% year-on-year in November. In contrast, inflation in the UK fell more than expected in November to 3.2% after 3.6% in the previous month. In Japan, inflation remained at around 3%.

In the USA, inflation surprised with a significant decline. After 3.0% in September, the year-on-year price change in November amounted to 2.7%. Due to the government shutdown at the time, no figures were collected for October. However, the fall in inflation should be treated with caution. This is because the change in the price level between September and November is only 0.2%. That looks implausible. Extrapolated to the year as a whole, this results in a value of only 1.2% (0.2% times 6 months). If we take a look at the price components, it is noticeable that the assumption for the change in housing costs is close to zero percent. It is becoming apparent that inflation for the month of December will be significantly higher.

Probably the last interest rate cuts for the time being

In the case of central banks, it is noticeable that developments are becoming more country-specific. The global cycle of key interest rate cuts appears to have come to an end. Firstly, following the third key interest rate cut in a row to 3.75%, the Chairman of the US Federal Reserve has signaled that a neutral key interest rate level has now been reached. However, the political pressure for further interest rate cuts is very high.

Secondly, the President of the European Central Bank announced at the latest press conference that she would not be providing forward guidance on future interest rate changes. This signals an unchanged key interest rate for the foreseeable future (at 2%). Thirdly, the Bank of England has cut its prime rate by 0.25 percentage points to 3.75% and is signaling further cuts. The rising unemployment rate and the stagnating economy are creating pressure for inflation to fall faster than expected. Fourthly, the Japanese central bank has raised the key interest rate further (from 0.5% to 0.75%) and signaled further increases. The interest rate level adjusted for inflation is too low.

 

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