First of all, we look at what would shift a soft-landing in the US into a recession, the consumer remains pivotal in this debate, but the picture is mixed across major economies. The risk of a consumer contraction is most likely in Europe, UK and Canada. Japan also seems to be slowing but no contraction implied at present. In contrast, consumers in the US seem to be fairly resilient, as Q3 spending is tracking at close to a 3.5% (annualised rate). As good as that may seem on the surface, there are cracks appearing in retail sales and guidance from companies.
We closely monitor the main drivers of consumption that the US Federal Reserve will also study for signs of either a downturn or stability and it would be fair to observe that at this stage, the key drivers are pointing to a weaker consumer outlook rather than a contraction. However, the situation can change rather quickly given the tighter financial conditions and higher oil prices in recent weeks that will inevitably sap demand for goods and services.
Turning to inflation, Has the Fed managed to tame US inflation, or will there be a second wave? Our base case at the start of 2023 was that the first half of the year would see significant progress towards a lower inflation profile, but that further reduction beyond that may become more gradual and we would re-examine the evidence. The current data aligns with our previous projection, with a slight variation: should the economy weaken further, inflation could approach the target sooner than anticipated by the Fed.
Both headline (August 3.7% y-o-y) and core Consumer Price Index (CPI) (August 4.3% y-o-y) data have eased considerably over the course of the year. The Fed’s preferred PCE readings have also moved lower, with the core reading in August at 3.9% y-o-y down from 4.8% in April. The FOMC’s most recent projections are looking for a shift lower through 2024 and target to be achievable in 2025 – but they may be a bit too pessimistic.
Some forecasters are now projecting a return to target inflation by mid-2024 and inflation expectations (the University of Michigan) is also encouraging. There are a number of key inputs that we are watching closely and, on balance, they are encouraging for inflation pressures to continue to ease in coming months.
To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q4 2023 here.
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