The global economy is in a state of flux, with various factors influencing its trajectory. Let's delve into the intricate dance of policy shifts, central bank decisions, and technological advancements, and explore their impact on economic growth and markets worldwide.
In the United States, the Federal Reserve is taking a cautious approach by restarting rate cuts, responding to a softening labor market and slower job growth. This delicate balance aims to support economic expansion without reigniting inflation, which remains a persistent challenge. Despite these challenges, equities continue to rise, reflecting investor confidence in the economy's resilience. Our experts predict a modest growth rate above consensus but below trend, aided by reduced trade uncertainties and the Fed's focus on labor dynamics.
But here's where it gets controversial... While the Fed's easing measures provide support, persistent inflation may temper the pace of these actions. The August CPI increase of 0.4% pushed annual inflation to 2.9%, the highest level since January. This creates a challenging environment for the Fed, which must navigate the delicate act of supporting growth without fueling inflation.
On the global stage, fiscal spending, central bank easing, and a weaker U.S. dollar offer temporary support. This suggests a moderated slowdown rather than a full-blown contraction, allowing investors to remain engaged. However, the overall landscape is characterized by broad uncertainty, with several dynamics at play.
Equities: Despite growth concerns, the S&P 500 has gained 14% this year, with earnings and margins surpassing expectations. Performance is broadening beyond big tech, with cyclicals, high beta, consumer discretionary, and equal-weighted tech leading recent gains. Our experts forecast earnings growth of 10% in 2025 and 13.5% in 2026, indicating improving profitability across a wider range of companies. The gap between the S&P 500 and the equal-weighted index is narrowing, providing evidence of this trend.
And this is the part most people miss... Our experts are particularly optimistic about the tech sector, where AI-driven demand for semiconductors and infrastructure is expected to sustain above-market earnings growth. Utilities are also attractive, with rising data center power needs and grid modernization efforts creating durable growth and steady dividends. In financials, a steeper yield curve, deregulation, and stronger deal activity may support improving profitability. Opportunities are also seen in industrials and consumer discretionary sectors.
Rates and U.S. Sovereign Bonds: U.S. sovereign bonds have delivered a return of over 5% this year, following a decline in the Bloomberg US Treasury Index. This is attributed to further weakness in U.S. yields across the curve, with the yield curve steepening in response to the increasing likelihood of Fed rate cuts. From a global perspective, U.S. rates are becoming more attractive to investors as we enter Q4, as the rate cycle for the rest of the world appears to be nearing the end of the easing cycle.
Credit: The historic tightening of credit spreads has surprised many, given mixed signals on growth in the U.S. and the failure of some sub-prime lending companies. Our data suggests that investors have continued to seek yield, with a notable increase in high-yield interest. The expectation of further Fed rate cuts has contributed to relief buying in high yields. Overall, credit markets have shown resilience, and the outlook for Q4 points to further stability despite economic slowing.
Foreign Exchange: The U.S. dollar's weakness, a dominant theme in Q2, was less pronounced in Q3 but is expected to continue in Q4. This is driven by increased hedging by cross-border investors, reduced hedging costs due to Fed rate cuts, and the impact of U.S. policy uncertainty on assets. As a result, USD positioning remains short but above historic lows.
Final Thoughts: As global markets navigate the shifting landscape, the Fed's cautious easing, resilient equity and credit markets, and a recalibrating FX environment reflect a delicate balance. In this complex environment, opportunities will arise for those who adapt their strategies swiftly. The key to success lies in understanding how these dynamics interact and unlocking value across asset classes.
