Recent macroeconomic developments have been broadly positive, despite the rise in tensions in the Middle East, says Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable Asset Management.
First, the September jobs report alongside strong activity data have dispelled investors’ concerns about a possible US recession. Activity surprise indices have turned positive for the first time since May. We continue to expect a soft landing for the economy, with growth slowing only gradually over the coming quarters.
Second, China’s government has announced both monetary and fiscal easing, signalling that the authorities have reached their pain threshold and are intending to stabilise growth. As a result, we have maintained our growth forecast for this year at 4.8%. On the downside, tensions in the Middle East have escalated, pushing oil prices higher, though they remain relatively low by recent standards. For oil prices to rise significantly, the situation would have to deteriorate sharply, likely involving a blockade of the Strait of Hormuz, which we consider unlikely.
Prices may still climb in the coming months. But this would reflect increased risk premiums (the geopolitical situation remains very fluid) and lower inventories in advanced economies, rather than reduced global supply. In Europe, the macroeconomic picture remains broadly unchanged. But at least, members of the ECB Governing Council seem more inclined to speed up their rate-cutting cycle.
After the summer lull, the US business cycle has strengthened again. The services ISM bounced back to nearly 55 in September, payroll growth at 254K far exceeded expectations, and the unemployment rate dropped to 4.1% as more workers who had recently joined the labour force found employment.
As a result, the Atlanta Fed’s GDP nowcast for the third quarter has risen to 3.2%. Revisions to past data also show that corporate profits and the household savings rate are quite a bit higher than previously measured. In short, the economy is doing better than was generally expected. We have revised our GDP growth forecasts up for this quarter and next, pushing our average growth rate for this year to 2.7% (from 2.5%) and for 2025 to 1.7% (from 1.5%).
Despite some cooling in the labour market, strong corporate profitability does not point to an imminent need for layoffs. As long as this remains true, the economy is more likely to soft-land rather than fall into recession.
As for the Fed, the 50bp cut in September, rather than 25bp, did surprise us. The data, in our view, did not call for a large move, but Chair Powell made clear during the press conference that this was a recalibration rather than the beginning of a rapid rate cutting cycle. We have left our rate forecast largely unchanged: we expect two more 25bp cuts this year (previously one) and four next year (previously five).
The market has now moved in our direction following the strong September Jobs report. While inflation rates have come closer in line with the Fed’s target since the turn of the year, robust economic activity means inflation will probably not move down in a straight line to 2% as the last two CPI reports highlight. Finally, the outlook for 2025 remains uncertain given the elections and the very different sets of policies both candidates have put forward.
Economic indicators in the Euro area were disappointing last month. They broadly reflect fading economic dynamics, a reflection of too-weak demand. We have kept our below consensus GDP forecast of 1.0% for 2025. In our view, restrictive monetary and fiscal policies will not allow for higher-than-potential growth. Note that the ECB expects GDP to grow by 1.3% in 2025, with quarterly rates of 0.4% from Q2 on.
Such projections are based on a stable unemployment rate and a falling savings rate, which would lead to stronger private consumption. We agree with the ECB that real household income should improve on the back of lower inflation and higher nominal wages. Yet we remain sceptical that households will spend as much as they could in this highly uncertain environment. A higher savings rate in the past quarters validates our concerns.
Additionally, we doubt that any boost to private consumption would be strong enough to incentivise companies to increase their investment spending materially as long as policy rates remain so restrictive. Taken together, it is telling that companies are now reporting that the lack of demand rather than the scarcity of labour is the main factor limiting production. As a result, vacancy rates have fallen, highlighting that bargaining power is shifting slowly away from labour to capital owners.
Given a less tight labour market, wage growth should moderate and contribute to lower services inflation. Companies in the services sector are reporting lower increases of input and output prices according to purchasing manager indices. The adjustment process in the manufacturing sector is more advanced as companies already report declining input and output prices. Overall, we have few doubts that inflation will fall towards its target in the coming 18 months. We have revised down our inflation forecast by 0.2 percentage points to 2.3% and 2.0% for this year and next.
We have not changed our view that the ECB will cut its policy rates in October and December. Recent ECB speakers seemed to have converged to that view. We have lowered our forecast for end-2025 by 50bp to 1.75% though – a level that we would consider to be slightly below neutral. We see few risks of a policy mistake if the ECB front loads some of the rate cuts as monetary policy will remain restrictive and contribute to lower inflation for quite some time.
Should wages and underlying inflation pick up unexpectedly in the coming months, the ECB could simply stop lowering rates further and keep them constant for longer. Instead, it could be a policy mistake not to lower rates fast enough. If inflation were to fall faster than nominal rates, real rates would increase and weigh unnecessarily on economic activity.
By Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable Asset Management
