By Rajat Bhattacharya– Global growth continued to slow in August, despite some resilience in the US, with the services sector weakening unexpectedly while manufacturing sector activity continued to contract. Europe led the downturn, with PMI data indicating services and manufacturing sector activity both contracting. While US growth perked up mid-year on summertime spending and housing investment, the latest PMI data suggests the services sector too is slowing. China’s growth continued to disappoint, despite policy easing in recent months, suggesting the need for fiscal stimulus to revive confidence.
Price pressures continued to wane as goods demand and supply chains normalise. While core inflation in the US and Europe remain well above central banks’ 2% targets, we expect easing shelter inflation in the US, slowing global growth and China’s deflation pressures to sustain the global disinflationary trend over the next 6-12 months. Markets underestimating scope of rate cuts next year: Money markets are anticipating elevated Fed and ECB rates for the next 12 months. We believe the Fed and the ECB are largely done with rate hikes as growth and inflation cool (ECB could hike once more due to still-elevated inflation). Both are likely to start cutting rates in H1 2024 as a downturn becomes more evident.
Macro factors to watch
The Euro area’s sharp downturn is the biggest economic surprise over the past month as markets previously expected a summertime boom in travel to last longer. The surprise contraction in services activity in August (PMI: 48.3) adds to the already contracting manufacturing activity. The slump is led by the region’s largest economy, Germany, whose export sector has been hardest hit by China’s slowdown. ECB President Lagarde reiterated her hawkish message in the face of still-high inflation (consensus core inflation estimate for August: 5.3%). Given the ECB’s sole mandate to target 2% inflation, we expect one more 25bps rate hike in September, before an evident growth slump leads to a rate pause, followed by a cut in H1 2024. US services, job market slowing: The US, the most resilient economy this year (Atlanta Fed GDPNow estimates 5.9% growth in Q3), is also showing signs of slowing. Service sector activity, the primary growth driver amid a manufacturing contraction, slowed sharply in August (PMI fell for the second month to 51.0), despite a summer boost to leisure-related consumption and housing activity. Meanwhile, US job creation has fallen short of expectations for three straight months, and job openings, hiring and “quits” rate continued to decline, underscoring softness in a key driver of consumption.
Nevertheless, Fed Chair Powell remained hawkish at the Jackson Hole summit, reiterating readiness to raise rates further, if needed, and keep them higher for longer to lower inflation towards the 2% target. We see a disconnect between flagging growth and Fed hawkishness. We expect the Fed to hold rates at 5.5% this year amid elevated near-term inflation but start cutting in H1 2024 as the growth slowdown and the disinflation trend become clearer due to the lagged impact of 525bps in rate hikes and dwindling pandemic-era savings.
China’s economic data continued to fall short of expectations and consumer prices have started contracting despite measures to revive the property market, consumption, and investment. Recent rate cuts have underwhelmed, highlighting the limits of monetary policy. Investors are looking for a decisive fiscal stimulus package to revive consumer and business confidence.
By Rajat Bhattacharya is a senior investment strategiest at SC
