Market expectations of central bank interest rate cuts in 2024 are reasonable, according to Gilles Moëc, the Axa group chief economist and Axa IM head of research, who presented Axa’s outlook for next year in Luxembourg this week. He painted a relatively rosy picture for the US and, to a lesser extent, stagnating Europe, pointing to evidence that inflation is finally under control and that political troubles are not yet certain.
“The Fed needs to cut very quickly and very significantly in 2024,” said Moëc, pointing to forecasts from the Congressional Budget Office, the International Monetary Fund and the Organisation for Economic Co-Operation and Development. “Inflation is falling and if the economy is slowing down, the economy is not falling off a cliff – it’s not a catastrophe.”
“It’s not the recession that we expect, but a slowdown, where the economy goes below trend,” he said. This view is helped by the fact we are experiencing “a pretty steep base of disinflation,” he said.
Politics downplayed
For Moëc, this economic shift will have a clear impact on 2024. While 2 billion people will go to the polls in various elections next year, Moëc said the only real issue is whether Donald Trump wins a second term in office as US president, with European populist right-wingers limited by the vagaries of coalition politics. He doesn’t see Trump’s return as a foregone conclusion given Trump’s legal troubles and the fact that the US economy can’t afford another round of his tax cuts.
Moëc acknowledged that dealing with rising interest rates had been quite painful. But he contextualised it by saying 5% interest rates in the US and 4% interest rates might seem horrible to the youngest in his audience. “For guys my age, it’s nothing by historical standards.”
A key element of his view was based on significant falls in yields of US-denominated 10-year long-term yields.
Really painful
The 10-year yield had had a rough ride in late 2023, he explained, with 10-year rates rising very quickly “to the point where honestly we’re looking at fixed income portfolios, things were looking really, really painful.”
“If you try to understand why the 10-year yields are falling and you break them down between the usual inflation expectations versus real rates”, he said. “Both components are going at the moment in the right direction.”
Based on a graphical representation of how the market has priced in what the Fed will do in 2024 and 2025, “the slope is getting steeper and steeper to the point where the market for the end of 2024 is now expecting the Fed to be 4.5%, basically more than 100 bps of cuts, with further cuts into 2025.” (1 bps is equal to 0.01%.)
Outside causes
Moëc clarified that there was nothing inherent in the US or EU economy that had triggered the inflation. “Our inflation started from the outside, did not start because our sort of intrinsic run-of-the-mill functioning of our economy was producing inflation.”
Inflation happened, he said, because after economies restarted after Covid, there was a massive supply-demand mismatch. The most important thing to notice is whether this global-level mismatch has been repaired, he explained.
Pointing to indicators of industrial delivery times, he said that in 2022, delivery times were six standard deviations above the long-term average. Today, they are back to the long-term average, he explained.
What doctor ordered
Turning to China, which is experiencing a bout of deflation due to a reduction in the demand for its output, he explained that despite the impact on Germany, which is seeing declining exports “I would say that at the moment, the slowdown in economic activity in China is precisely what the doctor prescribed from a selfish European point of view,”, because, he said, “we need to import deflation from China.”
He explained that the price of goods imported from China into the US was down 3% year on year in Q3 2023 based on US import price data
Even though inflation was started by outside factors, today there are some troubling indicators about how the economy is recovering. Moëc pointed to statistics on the price of manufactured goods in the US on the consumer level showing that prices are falling.” That’s a function of what I was describing as the normalisation of supply lines,” he pointed out.
Services still accelerating
On the services side, however, Moëc said we’re still facing a “reacceleration” of prices. “That is what makes the Fed nervous.“
Moëc said that he would venture to say that “even the domestic sources of inflation in the US are going to go in the right direction.” For him, what’s important to note are job creation statistics that he said are “below trend, below the pre-Covid trend.”
“It’s not a catastrophe, but it is cooling down,” he said. “and this cooling down of job creation seems to already be having an impact on wages.” Which can only help cool down the services sector.