Written by Anthony Willis, Investment Manager, Columbia Threadneedle Investments Multi-Manager team
It’s that time of year when shops start filling with Christmas goodies, the clocks have gone back, leaves are falling, and the kids wrap up warm for a Fireworks night out. It is also the time when investors consider what’s in store for markets over the final months of 2023.
It’s been a stronger year than expected for western economies and we’ve seen some decent returns in certain equity markets. No doubt the economic data is on a weakening trajectory. Growth in the US remains solid, while in the UK and eurozone it is significantly weaker, but still positive. So, why have economies continued to grow despite significant monetary headwinds in the form of hikes in interest rates?
A common theme across the US, UK and eurozone is consumer resilience, in spite of higher food and energy bills and housing costs for those that have had to refinance their mortgage or pay higher rental costs. It’s clear that the pass through from higher interest rates has had a longer lagged effect than in previous cycles thanks to mortgages being held by a lower percentage of households, and those with mortgages generally having fixed for at least 2 years, meaning a lower proportion of households have immediately felt the pain of higher interest rates. The main factor seen as helping consumer resilience is the pent-up savings and transfer payments from the time of the pandemic. Across western economies, consumers have been able to draw down on these excess savings over the past 12 months and this has substantially cushioned the impact from the rising cost of living. A key factor in our view that consumption will weaken over the coming months is the data showing these savings are close to being exhausted. Labour markets and wages have also shown considerable resilience over the year, with unemployment rates creeping higher, but not yet at a pace to weigh on consumer sentiment. Leading indicators on job openings and temporary staffing do suggest that we will see unemployment increase in 2024.
This year has seen the consensus view on economic growth has proved to be wide of the mark. We’ve seen the narrative shift between ‘hard landing’, ‘soft landing’ and ‘no landing’. While it’s clear that recession calls have been incorrect that does not mean we’re on the cusp of a period of economic strength. Indeed, the aggressive rate hiking cycles seen in the UK, US and eurozone are yet to fully impact on economies and there is enough evidence in the leading economic data to suggest that the coming quarters will see a decline in economic momentum, which in some economies could be enough to push growth into negative territory for two quarters, thus meeting the ‘recession’ definition. A key point is that there is potential here for differentiation, as economic trajectories diverge given central bank policies are unlikely to move in lockstep over the coming quarters. Across the UK, US and eurozone the central bank narrative is very much aligned in that they are ‘data dependent’ and reserve the right to raise rates further if inflation proves persistent.
Financial markets are apparently not convinced, taking the view that rate hikes are done, and history suggests that the top of the rate cycle rarely lasts more than a few months before rate cuts follow. Is it different this time? Central banks think so – their forecasts suggest inflation will remain a challenge for some time and, as such, have suggested that interest rates will remain at current levels for an extended period. It seems likely, however, that if we do see economies rolling over, central banks may well need to change their policy outlook.
As we gaze into the future we do see the economic headwinds increasing and are also cognisant that if we do escape a recession and fall into the ‘soft landing’ zone, that may well mean interest rates need to stay elevated for even longer to ensure inflation is defeated. While it may mean some short-term pain, the clearing event of an economic and earnings recession which brings about interest rate cuts may well prove to be a more positive ‘reset’ than a prolonged period of sluggish growth, higher inflation and elevated interest rates.
Navigating 2023 has not been simple, and we don’t expect our job to get any easier given the levels of uncertainty around the economic, (geo)political, and central bank landscape. We continue to have a relatively cautious view of the World but, as always, need to balance macroeconomic fundamentals with a view of whether that news is ‘in the price’. Given the very sanguine, near complacent, market mood the past few weeks, we do think that we will see volatility pick up, but that is no bad thing for the opportunistic and stock picking managers we seek to invest in.
