Forecast update: Soft landing has become more likely

There have been two notable positive macro events over the past month. First, the September US jobs report alongside strong activity data have dispelled investor concerns about a possible recession. US economic surprise indices have turned positive for the first time since May. Second, China’s government has announced both monetary and fiscal easing, signalling that the authorities have reached their pain threshold and are intending to stabilise growth, which we expect to come in at 4.8% for 2024. These developments support our view of a soft landing for the US economy, with growth slowing only gradually over the coming quarters. In Europe, growth remains sluggish and we have revised down our inflation forecasts for both the eurozone and Switzerland. We now expect the ECB and the SNB to cut rates next year by more than previously anticipated.

We see a favourable risk/return trade-off for fixed income instruments and continue to prefer intermediate maturities. We have a neutral assessment on credit, both for Investment Grade and High Yield for now. We expect the current dollar appreciation to continue over the coming weeks, which implies that the gold rally is unlikely to extend further in the near term. We remain constructive for the Swiss franc and the yen. On equities, we have upgraded our S&P500 targets for the coming quarters and remain positive on euro area equities. Chinese equities are not expensively valued, even after the recent rally. A potential pick-up in GDP growth would likely lead to earnings upgrades and allow for more gradual, but further upside in the short-term.

Monthly macro and strategy forecast update

Recent macroeconomic developments have been broadly positive, despite the rise in tensions in the Middle East. First, the robust US jobs report for September has eased investors’ concerns about an imminent US recession. We continue to expect a soft landing for the economy, with growth slowing only gradually over the coming quarters, and have revised up our GDP growth forecast for 2024 to 2.7%, from 2.5%. Second, China’s announcement of monetary and fiscal easing represents a significant shift, even though fiscal support is likely to be phased in gradually. As a result, we ha vemaintained our growth forecast for this year at 4.8%. In Europe, we have revised down our inflation forecasts for both the euro area and Switzerland, and now expect the ECB and SNB to cut rates next year more sharply than previously anticipated. In the fixed income space, we see the risk for bond yields to fall further over the next 6 -12 months and continue to favour intermediate maturities. We have a neutral assessment on credit, both for Investment Grade and High Yield for now. We expect the current dollar appreciation to continue over the coming weeks, which implies that the gold rally is unlikely to extend further in the near term. We remain constructive for the Swiss franc and the yen. On equities, we have upgraded our S&P500 end-year targets for the coming quarters and remain constructive on euro area equities while Chinese equities are yet not expensively valued, even after the recent rally. A potential pick -up in GDP growth would likely lead to earnings upgrades and allow for more gradual, but furt her upside in the short-term.

USA

After the summer lull, the US business cycle has strengthened again. The services ISM bounced back to nearly 55 in September, payroll growth at 254K far exceeded expectations, and the unemployment rate dropped to 4.1% as more workers who had recently joined the labour force found employment. As a result, the Atlanta Fed’s GDP nowcast for the third quarter has risen to 3.2%. Revisions to past data also show that corporate profits and the household savings rate are quite a bit higher than previously measured. In short, the economy is doing better than was generally expected. We have
revised our GDP growth forecasts up for this quarter and next, pushing our average growth rate for this year to 2.7% (from 2.5%) and for 2025 to 1.7% (from 1.5%). As we have argued over the past few months, despite some cooling in the labour market, strong corporate profitability does not point to an imminent need for layoffs. As long as this remains true, (we explain here why we think the profit share is unlikely to fall rapidly) the economy is more likely to soft-land rather than fall into recession.
As for the Fed, the 50bp cut in September, rather than 25bp, did surprise us. The data, in our view, did not call for a large move, but Chair Powell made clear during the press conference that this was a recalibration rather than the beginning of a rapid rate cutting cycle. We have left our rate forecast largely unchanged: we expect two more 25bp cuts this year (previously one) and four next year (previously five). The market has now moved in our direction following the strong September Jobs report. While inflation rates have come closer in line with the Fed’s target since the turn of the year, robust economic activity means inflation will probably not move down in a straight line to 2% as the last two CPI reports highlight. Finally, the outlook for 2025 remains uncertain given the elections and the very different sets of policies both candidates have put forward.

Euro area

Economic indicators were disappointing last month. They broadly reflect fading economic dynamics, a reflection of too-weak demand. We have kept our below consensus GDP forecast of 1.0% for 2025. In our view, restrictive monetary and fiscal policies will not allow for higher-than-potential growth. Note that the ECB expects GDP to grow by 1.3% in 2025, with quarterly rates of 0.4% from Q2 on. Such projections are based on a stable unemployment rate and a falling savings rate, which would lead to stronger private consumption. We agree with the ECB that real household income should improve on the back of lower inflation and higher nominal wages. Yet we remain sceptical that households will spend as much as they could in this highly uncertain environment. A highe r savings rate in the past quarters validates our concerns (Exhibit 5). Additionally, we doubt that any boost to private consumption would be strong enough to incentivise companies to increase their investment spending materially as long as policy rates re main so restrictive. Taken together, it is telling that companies are now reporting that the lack of demand rather than the scarcity of labour is the main factor limiting production. As a result, vacancy rates have fallen, highlighting that bargaining power is shifting slowly away from labour to capital owners.

The ECB should cut its policy rates at each of the next six meetings

We haven’t changed our view that the ECB will cut its policy rates in October and December. Recent ECB speakers seemed to have converged to that view. We have lowered our forecast for end-2025 by 50bp to 1.75% though – a level that we would consider to be slightly below neutral. We see few risks of a policy mistake if the ECB front loads some of the rate cuts as monetary policy will remain restrictive and contribute to lower inflation for quite some time. Should wages and underlying inflation pick up unexpectedly in the coming months, the ECB could simply stop lowering rates further and keep them constant for longer. Instead, it could be a policy mistake not to lower rates fast enough. If inflation were to fall faster than nominal rates, real rates would increase and weigh unnecessarily on economic activity.