Webcast – The global macroeconomic outlook for 2024

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Introduction

Johanna Lasker

CEO, BNP Paribas Asset Management USA

Welcome

Good morning, everyone. Good afternoon. Welcome to BNP Paribas Asset Management’s first Global Macro Discussion of 2024. My name is Johanna Lasker. I am the head of our official institutions team and the CEO of our North American business. It is my pleasure to welcome everyone to this first discussion of the year.

Our thought behind inviting you to this discussion was to create a forum, where we could really exchange views, particularly at the beginning of the year, we wanted to share with you how we’re thinking about the key markets around the world, and really importantly, hear your questions. So that this is part of the regular exchange that we have, but it also helps us hearing your questions will help formulate our views on what’s important to you, our clients and investors around the globe.

Agenda

To do that today, we’ve invited key members, actually most of the members of our Macro Strategy team, which is headed up by Richard Barwell. We’re going to ask each of them to speak about the markets for which they’re responsible. We’ll kick off with an overview of our general thoughts. Then we’ll have a bit of around the globe discussion. You’ll hear views on the US, on China, Emerging Markets and Europe, and then we’d really like to open the floor for your questions.

To do that on the platform, hopefully everyone sees a little Q&A box. You can type your questions right in there and I will keep an eye on the questions and make sure they get addressed as we go.

Let’s do it. Richard, over to you to set the scene.

Introduction – the cuts are coming

Richard Barwell 

Head of Macro Research & Investment Strategy, BNP Paribas Asset Management

Introduction

Excellent. Thanks, Johanna. as Johanna’s already said. I run the research team here in London, and actually I’m joined by most of our economists here today. We have Mark, we have Marina, we have Chang, we have Audrey and myself. we have plenty of economists and we have plenty of slides. We don’t have that much time, so I’m going to kick straight off.

Agenda

I’ll start our discussion. We’re going to try and keep it short, sharp and sweet and then leave as much time as we can for questions.   I’m going to give you a little bit of an overview of where we think there’s maybe a disconnect between our take on the macro and the markets. And then we’re going to get right to it on the kind of key regions of interest. We’ll end up with a little bit on Europe and the rest of – the Eurozone and the rest of Europe. And then we’ll come straight back and hopefully tackle your questions for us.

So why don’t I start here with what we think is going to be from the economic perspective, a kind of key theme of 2024. And that’s about the cutting cycle that we think is coming. And   for us, if I was going to identify a big theme, it’s that with the exception of one very large country, which we’re about to hear about, we think the market expectations for that easing cycle are a bit on the conservative side. And that’s based really around the kind of really fundamental smell test, which is when you’re thinking about in big round numbers, the stance of monetary policy, the first question you have to ask yourself   at the moment is, where are we? Are we restrictive? Are we accommodative?

Well, clearly at the moment, most people would think with the deposit rate at the ECB at 4%, the Bank of England above 5%, most central banks think they are, and we agree clearly in restrictive territory. They’re above that concept of neutral, which is where the policy rate should be when growth is a trend and inflation’s at target.

And these numbers are not known for sure, there are estimates, we think they’re roughly a core what the central banks think. The ECB is probably 2 percentage points above neutral. Bank of England could easily be 3 above. we’re comfortably there in restrictive territory.

Our call for this year, the reason why we’re challenging we think market pricing is too conservative is   as we get through the middle of this year, it’s going to get increasingly difficult to explain why rates are restrictive at all. Why rates aren’t already at a neutral setting?

The basic call | The long march back to neutral

As you can see from the table on the right here, which is taken from a couple of days ago, but the numbers really haven’t moved that much. In Europe, it takes about two years to get close to neutral. Don’t get all the way there. These numbers, again, are imprecise. In the UK, we get nowhere close within three years.

And for us, fundamentally given the growth picture in Europe, that seems off. Mark’s going to talk to you about the US in a second. But in Europe, just in this week we learned the eurozone basically didn’t grow at all and the UK economy shrank in Q4. This is not a kind of good setup, and I’m going to show you in one second. The inflation picture is also changed a lot as well.

But fundamentally, as I say, we think rates should be getting back down to neutral soon. The market says not so much, and that for us, that’s our big kind of fundamental call.

Here’s the logic explained. I mean if you look back over the past couple of years, very simple term, this is Mark’s line, he uses on a regular basis with our investors. Why did rates end up where they are? Well, inflation went up. It’s surged above the target.

Where are we now? Well, if you look at high frequency measures of inflation, it’s pretty much all the way back down near the target already and outside the US growth this week. So again, given that backdrop, the inflation problem looks to be solved and growth is weak.

Why wouldn’t rates in Europe broadly define the Eurozone and the UK and the rest be at least to those neutral levels?

We are assuming lots of cuts. How we could be wrong? Think about inputs to rules…

How could we be wrong? Well, we could be wrong because our estimate of what neutral is – could be – and it’s not just us, it’s central banks. It will be way off, way off, so much higher. So more like a 300 in Eurozone rather than 200.

It could be true, but   that’s nobody’s base case. Or we could be wrong because we could have the macro wrong. So it could be that inflation’s just going to prove much, much stronger over the forecast horizon. rates do need to remain in restrictive territory. Again, you get a little chart here on the right. When we look at the high frequency measures of inflation, we just don’t get that message from the data. The inflation problem seems solved.

Likewise, if we see an explosion in growth in Europe, well, then again, rates would have to stay restrictive to lean against that. That’s just not the picture we’re looking at. So again, here fundamentally we think the pricing for central banks outside the US looks too conservative to us, given our take of neutral, given our take of the macro-outlook.

CB Psychology | Over-hiking?

And here’s just another quick way to think about that. I said that rates went high because inflation went high, but we think something a bit more subtle happens as well at the same time. We think if you look at what central banks were saying during this period, there was an important shift in strategy. They moved away from the kind of business-as-usual approach from monetary policy, which we think was underpinned by a loss of faith, essentially in their models, in their ability to forecast inflation, coupled with an increased concern around the cost, economic and reputational with inflation staying high.

And as a result of that, we have what economists called over-hiking or what you can think of more practically as central banks taking out insurance hikes. They were so concerned that inflation would stay high, that we think they hiked maybe more than they otherwise should have done. It’s not a policy error, it’s a deliberate choice. But that insurance is not free. If you take rates too high to really be certain that inflation’s not too high, and that probably means it’ll likely end up too low and growth will be too weak.

Our point is, again, as we get more and more confident inflation problem has been solved, at some point central banks will need to switch back to business as usual. They’ll decide that insurance is no longer worth paying. And when that happens, it means you’ve got to take those insurance hikes out, you’ve got to cut quickly. So again, instinctively here we’re thinking if you believe this story, this narrative of how central banks have had to behave, you should be expecting soon some cuts in policy rates to take out those insurance hikes.

Wrapping all up, here is what we have. From a kind of basic macro perspective outside the US for Europe, we just don’t really see the case much longer in policy being above neutral at all. And it’s currently 2 to 3 percentage points. That’s a big gap.

And secondly, our take of central bank strategy during this period is that central banks raise rates, quote too much. They over-hiked, they put in insurance hikes, and they need to come back out again. And if you have that narrative, then it leads you to ask a very simple question. We went up in big increments when we were hiking, why is nobody expecting these central banks to cut in big increments of at least 50 basis points to get back to neutral fast?

And when we ask that question, the challenge we get from investors is typically, when was the last time you saw a central bank like the ECB cutting in 50 increments outside of an emergency? And their response is fair. And we think you are probably asking the same yourself as you listen to me, but we have a couple of points of pushback.

The first is, well, when was the last time you saw the ECB 2 to 3 percentage points above neutral? This restrictive with growth of zero and inflation, basically back to the target? That’s rare. And were you really surprised when the ECB hiked so aggressively? If they did, then isn’t it sensible that maybe they cut quite aggressively too?

And last but not least, for those of you who are old like me, your hair has fallen out, you’ve been doing this for longer than you care to remember, in the old days central banks met on a regular basis every month. Cutting 25 basis points a meeting allowed you to cut a lot over the course of a year. You only have eight meetings a year, 25 basis points per meeting means you come down more slowly.

Summary | Excluding the Fed, we are more dove-ish than the market

So, last but not least, and I’ll wrap up here and hand over to the experts. This is where we summarise it. Now, the market price numbers will move around a bit because what we drew the cybers a few days ago, but the fundamental message, leaps off the page.

What we’re doing here is comparing our views for policy rates at the end of this year and the end of next year.   what we think is pricing for the market. As you can see from the US, we’re not picking a fight with the market. As you can see from most other central banks in DM, we are. We don’t think enough cuts are priced in. And that we think is big narrative story of this year.

And with that, let me move over to the US and to Mark. Mark, over to you.

US

Mark Allan

Senior US Economist

US | Economic growth in 2023 was very strong, continued into Q4 

Thanks, Richard. I wanted to start on the US section. We’re really talking about growth. Because one of the big stories of last year was just how strong US growth was in the end, the US economy grew over 3% in 2023, a year that 12 months ago, people were expecting would see stagnation or even mild recession.

So really very resilient US economy. And with perhaps the exception of today’s retail sales numbers, the early indicators for 2024 suggest that resilience is continuing. See for example, the January payroll report.

And kind of when we look at – look out into the rest of this year, kind of thinking about what’s going to drive growth,   one important factor is clearly going to be the fact that US consumers are still spending down enormous stock of savings that they put away during the course of the pandemic. And they have enough savings still stocked away that they could continue to spend them through the course of this year at a similar rate as they did last year without using them all up. we think the underlying fundamentals for the US consumer labour market looking healthy, plenty of excess savings, fading memories of the inflation shock of 2021 and 22 should mean that US consumption stays resilient this year and with it much of the rest of the US economy.

That’s it. We don’t expect quite as strong growth as last year. But another year of somewhere around about trend growth looks to be in prospect on our forecast, which is clearly very different from the picture you’ll see in most of the other developed market economies.

US | Labour demand at the turn of the year was much stronger than expected

And kind of one place that that resiliency and activity is showing up is in corporate demand for workers. We had a very strong payroll report for January upward revisions to the pace of hiring in late 2023.

And when you look at the report looking for reasons to explain that, we think that the bad weather might have depressed job creation in January.  you might yet see another strong report in February when we get that in a few weeks’ time. And even things like the dispersion of job creation across the economy, which was being cited in late 2023 as a reason to worry has rebounded as well. it does it like job creation is broad based across the economy. And this, as I said earlier, will kind of help underpin the consumer through the course of 2024.

US | Wages

With that kind of strength in hiring, there’s obviously been concerns that firms are going to find – they’re going to run out of workers and going to have to stop paying people more. And wage inflection might take off again.

When we look through the wage data, we’re not that concerned. There was a bit of a spike in the headline series in January, but we think that’s probably noise and that prepared measure, which is for non-supervisory workers, which is where the kind of the most intense labour shortages were during the pandemic in the years after. It’s kind of shows kind of relatively continued job wage greater around 4%, which is higher than we saw pre-pandemic.

But because productivity growth is falling so well now, firms actually have their labour costs under reasonably firm control at the moment. We’re not expecting this kind of second – any kind of second round kind of impulse to inflation from labour costs.

US | Core PCE slowed significantly and is now back at target on an underlying basis

And on inflation itself, the inflation picture did change quite dramatically in the second half of last year. Core inflation came down particularly on the core PCE measure. We’re not actually expecting any further deceleration this year. We expect just a continuation on a sequential pace of where we got to, to last year.

Obviously, the January CPI report was a bit of an upside surprise, but we think even there, there are some kind of reasons to think that it’s not that big a surprise would translate into the core PCE measure that the Fed focuses on.   we do expect kind of core inflation to kind of run sideways from here. Indeed, we have it finishing close to target just at 2.25% at the end of this year.

Turning to monetary policy.

US | If the Fed’s not going to cut in March, when will it?

The question really is around when’s, when’s the Fed going to cut? I mean, Powell was pretty clear at the last press conference that it wasn’t in March. But when we look kind of through the data calendar as we run towards May and overlay that with the kind of comments Powell’s made around his reaction function, saying that he doesn’t want to wait till inflation to get all the way to 2% before cutting, but yet doesn’t want to cut. So as soon as March, we think all signs point towards a cut in May.

For them not to cut in May, we’d need to see kind of more surprises along this of in inflation along the kind of scale we saw in the January one, which is not our base case.   we do still expect a May cut.

US | Future direction of the Fed’s balance sheet up for discussion at March FOMC

The other thing on monetary policy is really the Fed’s balance sheet and part of the reason why the Fed is not going to cut in March, even absent the surprise in the January inflation data is because the FOMC is gearing up to have a major discussion at the next policy meeting about its quantitative tightening programme and how it should adjust it.

And it looks like we’re going to find out in the course of the aftermath of the March meeting or either March or in May kind of a new slower profile for quantitative tightening.   we’d expect the pace of QT to slower in the second quarter of this year and perhaps finishing in sometime in the first half of 2025. And that will obviously be leave the Fed with a somewhat larger balance sheet than it had going into the pandemic. But   they were a little bit scarred by the experience in the QT episode pre-pandemic, where reserves got too tight, and they had to deal with some disruptions in money markets. And they’re very keen to avoid anything like that ever again.

And overall, we’re looking at a Fed that we expect to cut five times this year, beginning in May, and then almost every meeting thereafter.

I’ll stop here and hand over to Chang.

China

Chang Liu

Senior China Economist, BNP Paribas Asset Management

CHINA | Are the latest GDP numbers a cause for concern?

Johanna Lasker: And sorry, Chang, to interrupt before. But just a reminder to everyone about the option to put your questions in the Q&A box. It’s no surprise, some questions came in while Mark was speaking about the US. But please continue to send in your questions and we’ll come to them after we hear from all of our experts. So sorry to interrupt Chang. Over to you on China.

Chang Liu: No, not at all. Yeah, so for China – sorry, I’ve kind of structured this around four macro questions basically about, starting with where the – what the latest data show us about where the economy is at the moment, then about the property sector, what is going on there, which has obviously a big drag on the economy over the last year. And then what’s happening on policy. And finally, where our base cases relative to consensus.

Just starting with the latest data. the Q4 GDP numbers showed a pickup in growth in year-on-year terms in China. all of the headline data in China typically published in year-on-year terms. But this was mainly – this pick-up was due to a flattering base effect from the late 2022 when China exited zero COVID. This was not a fair reflection of what’s really happening in the underlying economy.

If we look at data on season adjusted quarter-on-quarter terms, you can see on the – it’s hard to explain. I guess the top left chart here is you can see that growth slowed last month – last quarter to 1% to 1.5% in Q3. And similar distortions also applied for the monthly activity data in December.

Whereas, the year-on-year data showed a slowdown in retail sales growth and pick-up in industrial production growth and investment growth. This was not really what happened in the economy at all. the bottom three charts here show the data in seasonally adjusted level terms. And you can see on the bottom left here that retail sales growth actually ticked up at the end of last year rather than slowed.

Industrial production actually slowed slightly rather than increased. And the overall picture was just the economy showed modest growth really coming into 2024.

I want to focus a little bit on the bottom right chart here, which shows a breakdown of the investment data. You can see overall investment was still a prop to growth towards the end of 2023. The red line here is picked up by about 2% month-on-month, driven by stronger spending in infrastructure and in manufacturing. This is probably supported in part by stronger fiscal stimulus towards the end of last year.

But the big drag on the economy still remained, which is black line here on the bottom right chart. This is property investment, which plunged by 6% towards the end of last year.

CHINA | Is the property market getting any better yet and does it matter?

This is a closer look at the property market where things are getting any better. And most of the indicators towards end of last year showed things are still deteriorating. The top left chart here shows floor space started. You can see that after the surprise uptick in November starts decline further in December more than reversing the pickup in the previous month.

And then the bottom left chart here shows floor space sold. And you can see that’s just being on a downward trend and there’s no sign that is stopping. And this matters because I’m sure you know this, but property in China is 70% of household wealth and about a quarter of China’s economic output.

Residential forest space investment alone is about 10% of China’s GDP. And you can see on the bottom middle chart here, this is plotting starts, housing starts versus investment and housing under construction. And we have – we’ve had this sharp drop off in floor space started over the last couple of years or so as developers got into trouble and kind of run out of financing.

But so far this had a limited impact on investment because developers still have some funding they can use to work on existing projects. But if starts don’t pick up very soon, then this investment has to kind of drop in line with it because there’ll be no projects for developers to work on. And this will be a strong drag on the economy if that is not fixed.

So here I’ve shown our forecast in the dotted line here, and this assumes the rumour[?] in kind of 1 trillion maybe in property support is all kind of deployed and all goes into property investment this year. And even then, we still have a slowdown in property investment this year before kind of that kind of flattens out.

And the bottom right chart here just shows where two major sources of developer financing are. They’re still kind of pretty limited.

CHINA | Too little policy support or has the support been less effective than hoped?

  officials are obviously not blind to these risks. They know what is going on, and in fact, we’ve seen policy easing over the last two years as officials have tried to kind of tackle some of these issues.

The problem is that they’ve kind of consistently been kind of behind the curve in terms of market expectations. And a lot of these recent easing measures have come with caveats. They don’t really want to go all the way out or analysis bazooka like they’ve done in the past. And – but the good news is that this policy effort, this policy momentum has picked up lately. We’ve seen fiscal support being ramped up towards the end of last year with a mid-year budget adjustment with the central government now coming directly to help fund some of the – this infrastructure spending.

On property, we’ve swung from the three red lines in 2020, which limits the kind of amount of debt to the three minimums announced towards the end of last year, which put a floor on the property lending.   it’s been this wide kind of swing in property policy. And you can see more recently there’s been more implementation here with kind of white-listed real estate projects being released and the PBOC starting to support urban village renewal, I should say, with PSL[?] funds.

And more recently, the leadership made a rare move to intervene directly in financial markets with efforts to try and boost stock markets to revive confidence. This is again, really quite rare for China. The top leadership that typically doesn’t really pay that much attention to capital markets. It can be seen on 7^th February, right before Chinese New Year, President Xi actually visited financial regulators and replaced the head of the securities regulator after the market route.

CHINA | What do we think the China-watchers have got wrong?

We expect more policy to come through here with significant property policy king of underpinning our kind of view for China this year. Even then we still expect growth to slow from 5.2% last year to about only 4.5%.

In terms of calendar year growth, we’re not all that different from consensus, but as you can see on the middle-left chart, I guess our trajectory for growth in quarter-on-quarter terms is quite different. We have a further slowdown in growth over the next couple of quarters before pickup towards end of last year, the kind of U-shape recovery versus the end for the consensus. And this is because we think the consensus are far too optimistic on the property outlook. We still think that even with the one training we’re talking about for property support, that will still be a slight slowdown growth over the next couple of quarters.

Relative to the kind of broader market narrative, though, we are all more optimistic. I mean, after the Q4 GDP data was released and the discovery data was released, all the headlines were about how China’s stumbling into 2024 about how it’s hitting like more era – now era growth.

These are just far too downbeat considering what we’re seeing from the data. And a lot of the reporting is talking about property market weakness and the kind of divergence in the economy that we already really knew about. And if we do get this stimulus, we think that China’s recent period of deflation will also end and will have a mild inflation in the economy this year.

And I’ll stop here and hand over to Marina.

Emerging Markets

Marina Chernyak

Senior Emerging Market (exc. China) Economist, BNP Paribas Asset Management

EM ex-China | Above trend 2024-25, led by EM Asia and CEE recovery

Yes, thank you, Chang. Okay. you’ve heard Chang talking about China. I will cover the emerging markets ex-China growth and inflation here, as well as implications for the monetary policy.

This slide is about EM ex-China growth and the overall message here of overall surprising resilience, especially in the past couple of years after the pandemic recovery. EM ex-China growth recovery, it’s fair to say surprised both us and the Street economics consensus putting the kind of the 2023 growth overall above the pre-COVID average trend.

So our forecast, which you can see here in the dotted line on the left-hand side, it’s based on the assumption that this ongoing resilience carries on and that being possible thanks to the kind of domestic engines of private consumption and CapEx spending contributing – continuing to contribute to resilient growth despite exports and net trade being generally a drag along EM growth.

Our forecast remains above the Street here, as you can see about the orange line, although the Street has been lately kind of catching up upwards to ours as they kind of been revising their numbers to kind of to capture the upside surprises in the data.

So overall, for 2024 and 2025, we expect slightly above pre-COVID trend growth. This, of course, assumes no harm lending scenarios in DM, specifically the US and China.

In terms of the regional drivers on the chart on the right-hand side, we can see that EM, Asia, so the bright blue line remains the leading force and very resilient. It has a number of tailwinds that were kind of we were talking about since the middle of the last year. one is the semiconductors led export recovery that we continue seeing.

We are also seeing broadly in EM Asia a more finally a catch-up from the domestic demand recovery. And especially now that inflation has nearly normalised back to where it was in pre-COVID times, it should mean that the real incomes are recovering and that should continue to contribute to the domestic demand recovery.

And one last point of resilience for EM, Asia specifically is the ongoing supply chain shift away from mainland China in favour of EM Asia.

The kind of on the flip side of this is this time [inaudible] so CEMEA economies that have spent a chunk of last year in recession. But they started to recover in the second half of this year. And then you can see that LATAM growth has been overall exceptionally strong over the – in the past couple of years, but we think it should be going forward normalising to something a bit less impressive compared to what we have seen, several drivers. But then in general, one broad driver is generally worsening terms of trade.

EM ex-China | Inflation cooling remains on track but…

So that’s on EM inflation pictures. So really two messages here. One is that the bulk of disinflation that we have seen in EM is probably behind us, as you can see on the top-down measure from – on the left-hand side, both on the core and also on the headline measure.

And on the right-hand side chart, you can see this is also true on the regional basis. So – that’s kind of – there is a bit more room clearly there to move downward, but not much from here.

EM ex-China | Broad normalisation in the underlying inflation masks goods-services divergence

And the other point to make on inflation is that the normalisation that we have seen on the core inflation. So that’s on the left-hand side, it has been truly remarkable, especially the pace of it since the start of last year all the way into the summer. It has kind of dropped down pretty sharply stabilising and kind of moving sideways lately, but at decent levels, almost comparable to prehistoric levels.

However, this kind of broad positive trend of EM inflation normalising on the core measure is masking the divergence that has started opening up between the core services and the core goods prices. So that’s the chart in the middle of it. It’s a bit like in terms of dynamics that we are seeing in the rest of the DM economies.

Within the end there is a bit of a divergence here. for example, poor services prices are staying sticker – stickier in LATAM and CEMEA economies, not so much in EM Asia but we are seeing this trend in the North Asian economies like South Korea and Singapore, where core services prices are higher than core goods prices.

I guess one risk to keep in mind going forward by looking at this is that the resilience that we are expecting in domestic activity and in some places the fiscal consolidation this is going to remain basically an upside risk to core inflation over the next couple of years.

EM ex-China | Policy easing to broaden in 2024 but no rush to cut pre-emptively

Moving on to the monetary policy. So based on the inflation angle along, clearly, like I said, there’s a lot of room for EM central banks to ease monetary policy. In fact, we have seen EM, central banks – some EM central banks already starting to use monetary policy in the second half of last year.

In terms of the regional breakdown, you can see clearly from the chart on the left that LATAM central banks have the most room to cut from here followed by CEMEA central banks. EM Asia, not so much given that their policy rates on a kind of regional GDP weighted metric are already below the Fed.

However, we also know that EM central banks cannot ignore the external factors. among the main ones is basically the timing and the size of the event cycle in the US. And one final important difference, I guess between DM excluding the US and EM is that growth, as I said, has been holding up better than expected, but – so there’s really no urgency to cut – to start cutting rates aggressively.

Emerging market ex-China | Base case slide

So just to sum up, I guess one thing to say here, EM central banks will continue easing. This easing will become broader in 2024 as more central banks in EM join the easing cycle. But most of EM central banks will remain both dependent on domestic data development, that’s it for me, and I’ll hand over to Richard.

Eurozone

Richard Barwell 

Head of Macro Research & Investment Strategy, BNP Paribas Asset Management

Euro area | Inflation: What goes up must come down

Okay. Welcome back. We’re in the last lap now, so I’m going to cover off the Eurozone and talk about a couple of other DM countries. But I’ll do that quickly. Then I’ll bring us to a close and then hopefully we can get to answering those questions.

So one thing you might have thought at the start when I was speaking, when I talked about inflation outside the US and the rest of DM and I said, inflation is back to target, you may have thought that doesn’t sound quite right because core inflation, for example, in Eurozone is still above 3%. So why are they saying it’s back? And hopefully this chart will help you understand a bit where we’re coming from.

If you follow global data, your use of the – when the – in the US when we get an inflation number, it – they tell you about the change in prices on the month. And that gives you a real time sense of the underlying inflation dynamic.

If you focus on the data in Europe, you’re used to seeing a kind of conventional measure of inflation, the change between the price this month and the same month a year ago. Okay? It’s telling you about prices, but it’s telling you over a much longer interval.

And really the story of inflation in Europe is that the pace of increase on the month was very rapid at the back end of ‘22 and into ’23, but that’s now dramatically. On a year ago measures are still capturing a lot of that strength in the first half of ’23. But we try and do, for example, in the chart to the right is take a higher frequency measure.

For example, you take an average of the level of prices over the last three months compared to non-overlapping throughout before that, annualize that rate to give it an equivalent measure. And when you do that, you can see in the chart on the right how core inflation, if anything, actually is running at a below target pace in Europe already.

And it’s going to take some time for that to feed through beyond a year ago measure. But it’s coming. And as you can see from the chart here from Mario[?], who was our expert who couldn’t join the call today, that we can track that process through time. And based on our guess, core inflation should be below 3% already in February and should get to 2% in Q2. That’s well ahead of what the consensus have been expecting. It’s well ahead of what the ECB is expecting.

And that’s not just based on a guess, that’s based on what prices are actually doing on the month. And it’s this – and it’s in this sense we say inflation is essentially already back. Inflation’s already back, growth is basically zero, but rates are not. Rates are stuck there in Europe, 2 percentage points above neutral.

Euro area | ECB: Slowly turning the page 

The question is when’s the ECB be going to turn the page? Now it’s been a bit uncomfortable for a while, having this message telling people the rates are too high, they’re going to come down, and investors looking at you as if you’re crazy. Haven’t you seen the inflation numbers? It’s got easier. It’s got easier because some of the most hawkish members of the governing council are now changing their tone.

This is the Bundesbank President, Nagel, very respected. Even he’s saying that he’s convinced – the word convinced here is important, not he guesses, not he thinks, not he expects, he’s convinced that they’ve tamed the greedy beast of inflation. Another powerful member of the governing council, Wunsch from Belgium said, if the ECB was looking at just growth and inflation, they’d be cutting already. They’d be cutting already.

For us, we think the data tell you, the level of rates relative to neutral, you start listening to a member of the governing council, the trajectory is clear. And for us, the trajectory is they need to get back down to neutral fast. That means those 50s are going to become on the table in a way that the market’s not currently expecting. They’re just not quite ready to move just yet. And we think a lot of that has to do with reputational reasons.

Maybe we can come back to that in the Q&A.

Other Developed Markets

And then just in a couple of minutes then I’ll stop. I just want to say a word or two about a couple of other markets.

Summary | Base case views for UK and Japan

And maybe the best place to do that is here, which is our little summary forecast slide for the UK and Japan. This will be my second to last slide, and then I’ll stop.

I want to talk about these economies, A, because it just happens in the team, I cover them and I can’t stop talking about them, but also because   they’re interesting in two different ways. The UK is interesting because if you go back about nine months, one of the big themes in Macro was the UK has lost control of inflation. It’s way too high wages and prices, and that rates are going to have to move accordingly.

Over time the market’s got much more comfortable with the trajectory of the wage and price inflation in the UK. It looks better behaved, but the expectations for what the Bank of England will deliver have not. The Bank of England is expected, broadly speaking, to track the Fed. And hopefully, one thing you’ve really taken away from this call is that the UK economy does not look like the US. The US has had resilient growth. The UK’s had basically none.

So having a common monetary policy setting to us makes no sense. On the other side of that is this other economy, Japan, which really from a kind of central bank macro perspective, has been dull for a long, long time. But finally, we think we might be on the cusp of them actually getting their inflation up to the target, allowing them to exit their kind of extreme monetary policy setting.

They haven’t taken rates way above neutral in this cycle. They’ve been stuck down there with rates a little in negative territory. And for us, and again, maybe we’ll touch on it in the questions, we think we’re coming to the time where they at least take that first step in April of this year to exit negative rates.

Summary | We expect earlier and sharper cuts from the RBNZ vs Australia

With all that being said, let me just end finally on this slide again, it’s the big picture we want you to take away. Big picture, we think the market is roughly right, roughly right on the Fed. We’re not – the numbers can move around from day-to-day in response to today’s IP release. That’s not the point. Big picture, we’re not picking a fight there.

But for many of the other central banks in developed markets in Europe, it looks to us like the market is way too conservative on how many cuts are coming. We think these central banks are dealing with economies with no growth, where the inflation problem’s been solved, and yet rates are expected to remain restrictive for years to come. And that just doesn’t feel right to us.

With that last message, why don’t I stop here and then hand back to Johanna, and see Johanna, if you’ve got any questions for us from the audience.

Over to you, Johanna.

Q&A

Speaker (Company): Johanna Lasker: Excellent. Great. Thank you, Richard, and to the entire team. We do have a couple questions for you. They are about the US, they’re about China and they’re about Europe. Let’s see what we can tackle.

We can stick with you, Richard. Let’s tackle the question on Europe first, if that’s okay.

Richard Barwell: Sure.

Johanna Lasker: Give me a second to read this. Okay, so it says, cuts will come sooner or later, but what about long-term yields, like the 10-year? Do you think the current level in Europe and the US are normalised levels, given the ongoing central bank balance sheet reductions?

Richard Barwell: Okay. this is a question that I prepare for because it’s – the answer’s a bit tricky.   what we’ll do, we will come back and give you an answer. So sorry if this sounds like a political answer, but it’s an important one.

I’ll speak to you about the macro, but when we said we’d take this call, what we thought we would stick to a macro, we haven’t invited the strategists from our team on, and in particular, we haven’t invited the investors onto the call. We have experts in our investment teams who cover these issues in great depth.

And what I don’t want to give you is a view from, say, the economic perspective that may not chime with what the people who are actually in the portfolios, what they’re doing on a day-to-day basis.

What I’ll do is I’ll half answer the question, if that’s okay. And then maybe if it’s okay with you, hope we’ve got your name and details, we can come back to you with more colour on what our kind of – the heads of investment teams who are dealing in the rates market think on this question. Because there are a range of views.

To be crystal clear, if it wasn’t clear from the beginning. The role of our team is not to dictate a house view and every investment team follows directly from it. We are meant to be a key resource for them providing independent conviction views. We don’t set the view. And that’s why I’m always very careful not to cut across on a question of strategy rather than macro.

But the basic question you asked about the expectation of rates what you’re really, asking about the 10-year is not really what the ECB will do over the next two years. You are more asking about views around neutral and views about term premium to get what’s happening to, like, if you like the five year forward out, that drives a lot of 10-year yields.

The term premium is really a question that belongs more with strategists and economists, but the neutral is one that does sit with us. And again, it feels to me like if I had to – the place where there’s the biggest challenge is actually in the UK, because there, as I said, if you look at those forward rates, what seems to be implicit about the neutral, it does feel very high in the UK. It doesn’t feel comfortable for us but it’s at the same level of the US. That implied neutral in Europe is lower. And   I wouldn’t have such a disagreement there.

Beyond that, as I said, we have to have more conversation about the appropriate level of term premium. And thinking as you said – you mentioned central bank balance sheets. I would actually say on the team, and maybe actually somebody else in the team may want to chime in after that. That’s not, where we see the biggest concern. There’s a lot of angst in markets about the impact of QE and QT and central bank balance sheets on yields.

Actually, within the profession, the academic profession, the view is that the impact of those things on yields in the long run when markets are liquid is relatively small. It’s not zero, but it’s small.

Actually, the bigger question that we worry with, we grapple with are more fundamental questions to do with, for example, fiscal positions about the long run trajectory of debt issuance, and then the kind of bigger, broader questions about demographics and productivity. And   if I start speaking about them, I’ll never stop. But maybe that’s a topic for us to come back to next time.

I don’t know if there’s anyone else on the team who wants to chime in on that or maybe we should move to the next question, come back if there’s time. But we will come back and get one of our investors to come back and give you their perspective, the people who actually in the end trade the bonds.

Johanna Lasker: Okay. If no one else wants to chime in on that one, I’m going to go to our next question, which – let’s go to China. Okay. Chang, this one’s for you. And this comes back to your comments that – connect to your comments on the property sector. the question says that we’ve seen a lot of policy announcements over the past few years from China, but what’s different about the recent announcement that makes you think that these are going to help stabilise the property sector?

Chang Liu: Yeah, thanks.     the recent policy announcements are different, I guess in two main respects. One is just the speed of the rollout. We’ve seen a clear pick up in policy momentum towards the end of last year coming into this year, particularly towards the end of January before Chinese New Year, we’ve basically seen policy announcements almost every day. So there seems to be some shift in policymakers thinking in terms of their worries in the economy and what they’re willing to do to kind of support it.

The second difference is that for the property sector specifically, they finally seem to have crossed a line from just demand side supporting into supply side support. most of the last two years, the easing for the property sector has been on the demand side. easing kind of purchase rules, lowering mortgage rates, try and revive demand.

But the key reason for weak confidence in the sector is that developers are on the verge of default and no one there’s to buy a home from a developer, they don’t know if it’s going to survive for the next year or so.   what’s been missing, this kind of this supply side support and the latest round of support is targeting that now.   we’re getting direct financing support for developers, either through banks or through the PBOC or indirectly through kind of purchases of affordable housing or through the PSLs with the urban budget renewal.     that’ll be much more effective.

Johanna Lasker: Okay. Very good. Thank you, Chang. And then we’ve got quite a few questions on the US.   let’s see. It’s hard to know if we should start with the election or end with the election. We’ve got inflation, we’ve got the election and then the path of the Fed. Let’s stay with the Fed to start.

Mark, for you, what are the chances of the Fed staying on hold this year in light of the fact that the growth is so strong and the labour market resilience?

Mark Allan: This is a question that gets to the heart of the Fed’s reaction function and really explains why we say, so such a large market reaction to Powell’s December press conference. It’s kind of in the – kind of final few months of last year, there were two views on the Fed for 2024.

One view was the Fed’s a pragmatic organisation. If unemployment stays low, growth is 1.5% to 2% a soft lending in the real economy, why would the Fed cut? They’re only going to cut if something starts to go wrong.

And the other view, which is the one we’ve espoused for a long time was, well, rates went up to 5% because inflation was very high. And when inflation stops being high, rates wouldn’t have – wouldn’t be at 5% anymore. And Powell essentially settled that argument at Christmas. He came out and said, we’re going to cut when inflation comes down. And the question is when.

In January, he said they’re not going to be confident inflation’s going to come low enough by March but left it clear that at some point this year they’re going to be cutting. It’s a question of when.

For them to be on hold, it’s really going to be determined by the inflation data, they’re on hold in a world where this week’s January CPI number, it’s not a one-off. It’s – there’s a sequence of them that look like that. And the whole narrative around inflation starts to be reassessed. It’s inflation’s the driving the Fed this year, not the growth in the labour market picture.

Johanna Lasker: Fair enough. And you actually – we also had a question that you pretty much just answered about the recent inflation surprise, let’s say, and what the Fed was going to do as a result. You’ve just addressed that one. So then let’s do it, let’s talk about the election.

Mark Allan: Let’s go for it.

Johanna Lasker: The final question that we’ll tackle is about the election and the fact that it looks like we’re heading for a Trump versus Biden situation.   who do you think is the favourite at the moment, and what does it mean? What are the economic implications of that person winning?

Mark Allan: When you look at the opinion polls, particularly in those key swing states that are likely to decide the election in the upper Midwest, in Georgia and Arizona and Nevada, Trump is either ahead or level pegging with Biden in all of them. And three or four of them he’s ahead by around five points. That’s not a deterministic outcome of where the election is going to be. And there’s going to be a lot that’s going to happen between now and now and November.

But clearly in the campaign headquarters of Biden and Trump campaign staff would much rather have an opinion poll lead in February than an opinion poll be behind. Trump does have the edge right now. It’s a two horse – essentially a two-horse race. We don’t think the third-party candidates that are getting a – some degree of airtime at the moment are likely to be, to prove material in the end. And we’d say that probably Trump’s probably the favourite 55-45 something, something like that.

In terms of the kind of macro implications of, say, a Trump victory, it’s likely to come alongside a Republican clean sweep of, of Congress.   it would be a repeat of the 2016 outcome, where Republicans won the Senate, the House, and the presidency, which would obviously make life easier from a perspective of passing Republican orientated legislation in the first couple of years as Trump’s term.

And with Trump, one thing that everyone learned in the kind of first time he was in office was not to take any single policy pronouncement he made with as – a literal commitment of what to happen. For example, he spent a lot of time talking about how he was going to build the war and make Mexico pay, and Mexico didn’t pay for the water war construction, but immigration was a strong and powerful theme throughout his presidency.

And this time round, I don’t think anyone should take literally his kind of threats to start a global trade war and putting 10% tariffs on everything and 6% tariffs on goods from China. But clearly trade policy and Trump’s perceived view of certain countries taking advantage of the US through trade policy will be a theme of a Trump presidency. And you can expect that to be kind of something he would return to repeatedly through the course of his time in office.

For us, it’s an environment in which we’re unlikely to get any kind of material fiscal consolidation. Indeed, I suspect a Trump presidency would mean extension of his – of the tax cuts that were passed in, in 2017, particularly on the personal side. Maybe some more minor corporate tax cuts and large deficits on the federal deficit, as far as I could see.

In contrast, if Biden wins, he’s probably going to be facing a divided Congress and Republicans like to take the Senate. Democrats might take the House if Biden is re-elected. And in that scenario, you could imagine that perhaps there’ll be some mild fiscal consolidation, not anything material, but something mild that might come around the bipartisan basis.

But one unifying theme that is there between both Biden and Trump is perceptions around China, both on the national security type basis of being a threat and something that needs to be dealt with. And on a perception of trade and manufacturing jobs. When Biden was a first president, went and stood in a picket line when the auto workers were on strike a few months ago. Both of them see China as having stolen good manufacturing jobs and want to take action to try and get them back.

Biden’s approach has been more tactical, more subsidy-led than the approach Trump took. But both are trying to achieve a – similar objectives through different means. And     the US-China relationship, whoever wins the presidency is going to remain in focus in 2025 and beyond.

Johanna Lasker: Thank you, Mark. Yeah, clearly a topic we’re all going to be watching carefully, not just from a US perspective, but for implications for each of the regions that we’ve talked about today.

We will close out there. I will thank each of our participants for the questions you’ve sent in. Hopefully, this is just the beginning of a conversation with our teams. We welcome you to reach out with additional questions, both for us to answer on direct conversations, but also to help think about the next time we get together and the topics that are most important to you.

As I said at the outset, it does help us understand better what’s important to you, to our investors and helps formulate our strategy as well.   thank you for those questions. Richard, thank you to you and the team for your contribution. Very much appreciated.

And just one other comment for our participants today, if there are any particular slides or a particular chart, for example, that you found noteworthy or interesting, do not hesitate to reach out. We’d be happy to share with you what we can.   feel free to get in touch with us along those lines.

With that, I will thank you all once again and look forward to seeing you next time for the continuation of the conversation. Thanks, everyone.

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