The first half of 2024 saw a gradual deceleration in economic growth across the western world. In the US, concerns about overheating (which had emerged towards the end of Q1) diminished, and hopes for a soft landing revived. In Europe, momentum remained positive as the impact of the cost of living shock improved.
Continued economic growth came at the cost of persistent inflation. Indeed, services inflation remained above central bank targets, reinforcing concerns that the final stages of inflation control would be particularly challenging. Because of this, markets anticipate fewer rate cuts than they did at the beginning of the year. Our baseline assumption is that the Federal Reserve (Fed) will be inclined to cut rates at some point this year, but even then, the approach will be exceptionally gradual.
The ECB (European Central Bank) became the latest major central bank to cut rates (in June). Despite this, fallout from the European parliamentary elections and the announcement of snap French elections led to a rise in European sovereign yields.
Similarly, persistent services inflation dashed hopes of a June rate cut in the UK, despite signals from the Bank of England (BoE) that it could have been an option. Helpful year-on-year comparisons meant that UK headline inflation temporarily returned to target in June, and the BoE is expected to cut rates in August.
Markets
Overall, the second quarter built on the successes of the first, with risk assets broadly delivering another set of positive returns, as investors were willing to trade fewer rate cuts for better-than-expected growth and corporate earnings news.
Despite some cracks appearing in US consumer data towards the end of June, economic momentum remained positive, and the main equity indices remained strong as valuations stayed high among the mega-cap tech names.
The leadership of equity markets remained exceptionally narrow, particularly in the US, with a small number of AI-related stocks outperforming all other areas of
the market.
Benchmark equity valuations do not appear stretched on an equally-weighted basis, but many equity names are walking a tightrope: resilient economic activity in the second quarter led to resilient corporate earnings, but earning expectations are elevated and thus difficult to meet.
Fixed income investors have had to contend with a dramatic shift in rate expectations in the first half of the year, but the outlook remains attractive. Higher coupon yields, subdued nominal GDP growth, and a gradual shift in central bank monetary policy towards moderate easing should help bonds yield above-average returns over the next 12 months and beyond.
To read the full AndPapers Q3 2024 click here.
