Economic Overview
Employment data from the United States in early April presented a robust picture, with the economy adding a staggering 303,000 jobs in March, surpassing market expectations. America’s unemployment rate edged down to 3.8%, but the big news was inflation rising to 3.5% over the 12 months to March, up from 3.2% in February. Higher prices for fuel, housing, clothing, and the cost of eating out drove the increase.
Bets on a Fed rate cut tumbled in mid-April following the surprise increase, causing American bonds to spike – the US Treasury 10-year yield approaching 4.5% and some market commentators forecasting it could climb to 5% with the economy growing at or above trend and elevated American inflation being more persistent than expected. The March CPI numbers led to market mutterings that zero cuts in the Fed’s base rate in 2024, or even a rise at some point, could now be possible; speculations which sparked the ‘worst rout’ and sell-off of US bonds since September 2022.
As a result, despite the Fed projecting it would cut rates by 75 basis points this year, even that is now looking less likely. Fed funds futures contracts for December’24 are now showing a consensus of around a 60-basis point cut in total this year, compared to the 150 basis points priced in by markets at the start of 2024.
Europe is now experiencing a different scenario - Euro area annual inflation is expected to be 2.4% in March 2024, down from 2.6% in February according to flash estimates from Eurostat - this would be the lowest inflation number for 2 years or so and would significantly raise expectations of imminent ECB rate cuts. Germany, facing a likely recession after GDP contraction and manufacturing sector stagnation, reflects broader Eurozone challenges amid high energy prices and supply issues.
China shows signs of economic recovery, with factory activity growing for the first time in half a year. However, this growth occurs within a context of heightened geopolitical tensions, particularly with the United States, which has expressed concerns over China's manufacturing and trade practices.
In the United Kingdom, the economic outlook is cautiously optimistic. The Office for Budget Responsibility slightly increased the growth forecast for 2024. Fiscal measures aiming to stimulate short-term demand include tax cuts and freezes on duties. These efforts, however, coincide with the potential for post-election fiscal tightening and the ongoing challenge of elevating productivity for long-term economic health.
Monetary policy remains a focal point globally, with central banks closely watching inflation and employment to inform their decisions. Much like the ECB, the Bank of England is now expected to diverge in policy from the Fed and cut rates much earlier, albeit the depth and timing of the first cut is still hotly debated.
As the global economy progresses through 2024, the divergent trends across major economies underscore the complex interplay between employment, inflation, and strategic responses by central banks and governments. The US boasts strong job growth but faces inflation and debt concerns. Europe struggles with recessionary pressures, China experiences a resurgence amid geopolitical scrutiny, and the UK exhibits guarded optimism with an eye on fiscal challenges ahead. The actions of central banks and governments in response to these conditions will be critical in shaping economic outcomes in the months to come.
The one factor common to all the major economies at the moment is geopolitical risk. These centre on four main stress zones, all which risk disrupting supply chains and increasing trade costs:
- the impact of the Houthi insurgency in the Red Sea,
- the ongoing Hamas-Israeli armed conflict,
- the seemingly endless Russian-Ukrainian war, plus
- ‘Doomsday scenario’ speculation about deteriorating Chinese & Taiwanese relations.
"Monetary policy remains a focal point globally, with central banks closely watching inflation and employment to inform their decisions. Much like the ECB, the Bank of England is now expected to diverge in policy from the Fed and cut rates much earlier, albeit the depth and timing of the first cut is still hotly debated."
A more practical concern for businesses is the risk of cyber-attacks motivated by these geopolitical tensions (for example - the Czech Transport Minister warned this month that “thousands” of attempts to interfere with train networks, ticketing and signalling systems by “pro-Russia hacker groups” had been observed since the Ukraine invasion began), together with fears of weaker demand and the threats of higher energy prices &//or reduced energy supply to economies stemming from Middle Eastern tensions.
Financial sector stability risks have also increase, particularly within certain commercial real estate markets, where a sharp contraction in values across several advanced economies is observable. Major restructuring and debt burdens in the mainland China property sector also poses a contagion concern with potential repercussions for the UK and other nations. The scale of the losses in either area could precipitate creditor setbacks and disrupt UK financial steadiness through macroeconomic and financial market spillovers, contagion to UK banks' funding conditions, and a contraction in international financing for the UK commercial real estate segment, potentially exerting additional downward pressure on UK valuations.
High levels of public debt in major economies remain a persistent hazard to the UK's financial equilibrium, particularly against the backdrop of an ongoing constriction in financial conditions. However, the UK banking sector remains robustly capitalized and able to support the economy, even if financial conditions deteriorated significantly beyond current projections.
The Consumer Prices Index (CPI) registered a 12-month rate of 3.4% as of February 2024, a deceleration from the 4.0% rate recorded in January 2024. This movement in the annual CPI rate reflects the interplay of various price changes. Notably, the food sector, along with restaurants and cafes, exerted significant downward pressure, while the sectors of housing, household services, and motor fuels contributed the most to upward pressures.
This trend then continued into the ONS’ March data with CPI slowing again to 3.2%. This was slightly lower than markets expected, but this is perhaps partly due to the lag in the ONS data (April will see the impact of a ~12% cut in the OFGEM energy price cap drop in which is likely to bring headline inflation below 3%) as well as the new ONS PIPR measure of residential rental price inflation which has led to a upside recalibration of the housing cost components of the main consumer price indices.
The pattern of ‘two steps forward, one step back’ in the month-to-month inflation data which started in early 2023 seems set to continue in the short term, with the long journey back to the central bank’s 2% target a harder and longer road than first hoped.
“My New Year prediction of a rate cut on May 9th is fast receding, despite poor GDP figures, the ending of hawkish votes (at last!) to increase base rates to 5.5% and Feb’s falling CPI numbers. With just one member of committee voting for a cut in March, I fear there is still some way to go before a majority of the panel votes to reduce rates, especially given the ongoing persistence of services inflation. I retain hope though that if we see another significant CPI drop into mid-2% territory following the MPC’s April break, they could be persuaded to act sooner than markets are expecting and certainly before the Fed.”