Next year will hopefully be different
Bond yields have eased a little in the past week. Although economic data remains buoyant, even strong, in autumn 2023, there are widespread expectations that activity will slow into 2024. Investors think that eventually this will allow central banks to ease interest rates.
The USA represents the strongest part of the world economy. Forecasts had steadily risen for GDP growth in the third quarter; in the event the statisticians reported that the US surged by 4.9% on an annualised basis in Q3, after only 2.1% growth in Q2. This was led by a strong consumer sector, benefitting from a buoyant labour market, while the economy has been supported by the largest budget deficit since the 1950s (outside COVID). Business surveys suggest further expansion into Q4; in October, the S&P manufacturing PMI rose to 50 with the services index up to 51.
Looking ahead, high borrowing costs should help the economy slow into 2024. Fed Chair Jerome Powell has said that rising market rates could “at the margin” make central bank action less necessary. However, he warned that the central bank is “attentive to recent data showing the resilience of economic growth and demand for labour”. Hence, “additional evidence of persistently above trend growth, or that tightness in the labour market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy”.
Economic activity is rather weaker across the Atlantic. The UK PMI business survey showed the manufacturing sector still weak (at 45) and services hardly expanding (close to 50), whilst the CBI reported that manufacturing orders were their weakest since Jan 2021. Retail sales were weaker than expected, down about 1% in September and close to 4% annualised in Q3. Households are concerned about their finances; the GfK Consumer confidence index showed the largest monthly decline since a one-off survey at the start of Covid, and before that 1994. Such weakness is occurring despite a budget deficit running about 5.5% of GDP, up from 3.8% a year ago. Although the unemployment rate was reported unchanged at 4.2% in the 3 months to August, there are serious concerns about a new methodology, which means that the MPC is flying partially blind into the autumn.
The European Central Bank shocked nobody by leaving interest rates unchanged. Comments from Christine Lagarde were interpreted as signalling that rates have reached their peak; she sounded more cautious on economic developments and stressed the ‘higher for longer’ theme a bit more than at the September meeting. Such caution is understandable bearing in mind recent economic reports. The HCOB manufacturing PMI survey fell to 43 while the services index eased to 48, so the composite figure was at its the lowest level since March 2013, outside of the COVID pandemic months. The Bundesbank has warned that Germany’s economy likely contracted in Q3, blaming declining industrial production, a shrinking construction sector and weakening consumption. Eurozone bank lending continues to contract, under further pressure from both weaker demand and tighter credit conditions. The risk of doing too much will feature in the ECB debate in coming months, especially as the central bank expects the greatest impact from higher rates to appear in the first half of 2024. Money markets currently expect around rate cuts of about 0.75% by end-2024.
Might China come to the rescue and provide a major boost to the world economy in 2024? This looks unlikely. The National People’s Congress has approved a moderate increase in the budget deficit to spur infrastructure spending and encourage economic growth. However, economists generally see this as supporting current rates of growth rather than transforming the outlook. All in all, Q3 2023 looks to be the peak for economic activity and a slow deceleration appears likely into 2024. As long as this constrains inflation expectations, so central banks will remain on hold and bond markets will price in eventual rate cuts.
Bond yields at the time of writing
% 2 year 5 year 10 year
USA 5.07 4.85 4.934
UK 4.87 4.60 4.65
Germany 3.13 2.72 2.85
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making