• A fragile marker, but no panic: A short period of high volatility in July and August, caused by the reversal of the carry trade of the Japanese yen and weak macroeconomic data from the US, signaled some market fragility, but they are currently calm with a positive attitude towards high-risk assets, indicating a low reading of our turbulence index.
• Recession in 2025 or not: The probability of a recession in 2025 is estimated at 25%, although the delayed impact of a period with high-interest rates is still difficult to determine. Despite some weakening visible in readings of some data, key indicators such as growth, capital expenditure, and job offers suggest that the economy is not yet in recession.
• Rate cut cycle and US elections to dominate macroeconomics in the fourth quarter: The fourth quarter will focus on incoming data and how it will affect Fed rate cuts and the US election. The historic cycles of interest rate cuts were often beneficial for stocks, though the outcome of the 2024 election – whether it’s a Harris win with a parliamentary clinch or Trump’s victory on all fronts – will have a significant impact on the economy and specific sectors such as defense and technology.
• Investment allocation: With a calm market environment and inflation still above the Fed’s target, expected returns from commodities have dropped, causing investors to assess their investment portfolios based on historical data and current economic conditions.
Subtle signs of fragility, but no panic
The decline in stock prices, especially technology company stocks in July and early August, when the carry trade on the Japanese yen ended due to a change in the Bank of Japan’s monetary policy, was a small sign of market instability. Combined with weak US macro data relating to the labor market and inflation, the market began to change its stance on the path of Fed policy, assuming an aggressive interest rate cut cycle by the summer of 2025. Volatility briefly rose, then stabilized again and returned to normal. Perhaps this was a sign of what’s to come if there is a larger rotation in investment preferences. Despite a slight hiccup in financial markets in the third quarter, our turbulence index, which measures the degree of divergence between the behavior of key asset classes, remains low. This degree of calm in the market, if maintained, suggests positive prospects for risky assets.
Recession or no recession in 2025?
In the fourth quarter, financial markets will focus on key events such as the Fed’s rate cut cycle and the US elections. While both factors are important, the real question over the medium term for the stock market is whether the economy will fall into a recession in 2025. Based on the factors listed below, the likelihood of a recession starting next year remains low, but not so low as to rule it out altogether, and we set it at 25%. However, the delayed impact of higher-interest rates is still a big unknown in the recession equation, and so the 25% likelihood reflects a likelihood above normal.
Factors indicating the possibility of a recession:
• Indicators measuring US real-time data suggest about a 2% real GDP growth
• Financial conditions remain conducive in the context of economic activity
• The capital investment boom in technology and healthcare continues
• Stocks at record levels, and uncertainty associated with high-yield bond financing is minimal
• US job posting indicators of high frequency have stabilized since May
• The nominal GDP of the United States was 5.9% YoY in the latest reading
• European indicators analyzing real-time data suggest that the economic situation remains weak
• Wage growth remains high in both the US and Europe
Despite areas of weakness in the economy, our overall assessment is that the economy has slowed down, but has not yet fallen into recession and we think it is still too early for a significant rotation of investment portfolios towards defensive sectors.
Rate cut cycle and US elections will dominate macro data in Q4
The fourth quarter will be dominated by debates about the pace of the interest rate cut cycle in the United States and the upcoming November 5 elections. Two rate cut cycles in 2000 and 2007 have convinced investors that the one we are currently dealing with will also trigger a recession. However, it is essential to familiarize oneself not just with this recent history for a better understanding of the situation. Yes, the current valuation of the Fed’s interest rate fund for the next 12 months approximates previous recession-triggered rate cuts. But when we include inflation, current valuations seem to reflect only a reduction in the level to adjust to lower inflationary pressures. Secondly, previous interest rate cut cycles were mostly positive for stocks, and the only exceptions were the 1973, 2000, and 2007 cycles. Although interest rate cuts are an important signal for investors, we believe they should remain optimistic and consider whether their portfolios contain suitable elements in the face of the Fed’s interest rate cut.
This year’s US elections are likely the most significant elections in recent history. In the face of political division in the US, the election result will impact both the economy and financial markets. Of the most probable scenarios, a Harris win causing deadlock (Harris as president, but without control of the Senate) will likely be the worst for economic activity, as the fiscal impulse will likely be negative in this case; a blocked US Congress will make passing anything, apart from executive orders, difficult in the coming years. Another scenario is a Trump victory and a win for Republicans in both houses of Congress. This scenario will have a substantial positive impact on the European defense industry and likely a negative impact on technology and emerging markets due to Trump’s ideas regarding high tariffs.
Also possible is a Trump win scenario that also creates a deadlock. In this variant, he wins the presidency, and the Republicans take over the Senate, but fail to take the House of Representatives. We get both political deadlock and a decrease in the number of fiscal stimuli, but also new high tariffs.
Investment allocation
Each investment allocation is unique as it depends on individual risk preferences and return objectives. To eliminate human individual preferences, it is worth looking at the overall picture of asset allocation based on statistics. The current situation resembles that of the third quarter, characterized by a low turbulence index, with inflation still exceeding the 2% Fed target. Based on periods with similar conditions since 2007, annual returns for key asset classes can be calculated, which will help investors understand how different assets have performed in the past under similar circumstances.
Peter Garnry, Chief Investment Strategist, Saxo Bank
Source: https://ceo.com.pl/prognoza-makroekonomiczna-wystartowal-cykl-obnizek-stop-procentowych-w-usa-77084
