A look back at the summer of 2024
Macroeconomic developments
Macro surprises deteriorated over the summer before stabilising in September. The slowdown in activity is most marked in the developed countries (United States, Europe) and China. Nevertheless, global growth remained at satisfactory levels, close to 3% (Purchasing Power Parity) in Q3 according to the August composite Purchasing Managers’ Index (PMI).
In the United States, the signs of a slowdown have multiplied: a fall in household and industrial confidence, with the manufacturing PMI at its lowest level since the start of the year, and above all a clear slowdown in the job market: weak job creation (116k monthly average over 3 months), and a rise in the unemployment rate (4.2% vs 3.4% in April 2023). This has fuelled fears of a “not so soft landing”, or even a “hard landing”, leading to a powerful bond rally.
In the Eurozone, macro surprises have fallen off and the start of Q3 appears sluggish (contraction in retail sales and industrial production in France and Germany in July). The further deterioration in manufacturing PMIs in August prompts caution, especially as the rebound in the composite European PMI is only explained by the jump in the services index in France in the wake of the Olympic Games.
Disinflation, meanwhile, has deepened (now running at 3% worldwide). In August, US inflation rose by 2.5% over 1 year (its lowest increase since January 2021) after 2.9% in July (+3.2% for core inflation). Overall, robust productivity gains, wage moderation (3.8% in August) and low energy prices argue in favour of a continuation of this trend. Total inflation should come out at 2.5% in Q4 2024 and 1.9% in Q2 2025 (consensus: 2.6% and 2.1%).
Against this backdrop, the Fed decided to begin its monetary easing with a 50bp cut to 5.0% (upper bound) on 18 September. Aside from the 1st dissension within the Board since 2005, the justifications for the scale of this cut are not easy to find in the Fed’s new projections for growth or inflation: (slight downward revision of the underlying consumer spending deflator to 2.6% in 2024 and 2.2% in 2025) or in the FOMC statement and/or Powell’s speech.
The ECB continued the easing it began in June, but without taking excessive risks (-25bp) and maintaining its tough rhetoric on inflation.
Political front
The summer was marked by Joe Biden’s withdrawal from the presidential race on 21 July in favour of Kamala Harris. This was accompanied by a clear upturn in the polls in favour of the Democratic candidate, both at federal level and in the 7 key states (as of 18 September, K. Harris was ahead of D. Trump in Wisconsin, Michigan and Nevada, neck and neck in Georgia and Pennsylvania and well behind in Arizona). In short, nothing is certain, but in any case, this election will have repercussions in terms of growth and inflation, with a greater fiscal stimulus under Trump.
In Europe, the effects of French political risk remained fairly localised. Although uncertainty has eased following the elections and the appointment of Michel Barnier as Prime Minister, it remains sufficiently powerful to fuel the French risk premium. In fact, the political landscape is highly fragmented, with discussions on the budget due to begin in early October.
What about markets?
After peaking in mid-July, global equities began to fall as fears about the US economy mounted, before falling sharply in early August (jobs report/unwinding of carry trade positions). Since then, there has been a significant repricing of expectations of rate cuts, leading to a significant easing in yields, mainly driven by the short end and the real rate (at least in the US). Against this backdrop, despite a rise in volatility, the rebound in equities has been powerful (10% from the trough to today). At the same time, the dollar fell, particularly against the euro (almost 4% in 3 months to 1.12). Oil fell (-12% in 3 months) back to 74 dollars, with economic fears clearly outweighing geopolitical considerations or OPEC.
On the fixed-income markets, with the increased uncertainty surrounding the US economy, expectations of Fed Funds rate cuts rose, and sovereign yields fell. This was more marked in the United States than in the eurozone, with the decline being more pronounced on the short end and essentially driven by the real end, at least in the United States (-45bp vs +16bp in France). Overall, over the last 3 months, in nominal terms, the 2-year T-note has fallen by more than 110bp to 3.58% (compared with a peak of 5% last April), i.e. almost twice as much as the 2-year OAT (down 65bp to 2.44%). On the long side, the 10-year T-note fell by 50bp to 3.71% compared with -26bp for the 10-year OAT at 2.93%, leading to a clear steepening of the curve. On the European corporate credit market, performance over the past 3 months has been robust, with sovereign yields falling and spreads compressing. Continued high risk appetite has enabled the HY spread to outperform significantly (-50bp vs -11bp for the IG spread). At present, credit spreads are consistent with default rates of around 2 to 2.5% in both the United States and the eurozone (i.e. 2 to 3 points lower than current levels). The market is therefore still very much pricing in the idea of a soft landing. This is also reflected in the marked easing in the spread between banks and corporate bonds, with the disappearance of the premium built up in the summer of 2022.
On the foreign exchange market, there have been very significant movements since the start of the summer, between confirmation of the Fed’s easing, the BoJ’s normalisation and the unwinding of carry trade positions. As a result, the real effective dollar has fallen by 3.5% since its peak in early July. Over 3 months, the euro has appreciated by almost 4% to USD 1.12. In China, the yuan rose by 2.7% (back below 7.10). In Japan, with the central bank bucking the trend and fuelled by the unwinding of carry trade positions, the yen jumped 10% over 3 months to 142 (vs. 160 at the start of July).
On the equity markets, despite the growing doubts surrounding the tech sector, the violent correction at the beginning of August (which saw the Topix plunge 20% and the MSCI World plunge 6% in dollars from peak to trough) and more generally the rise in volatility (with the Vix peaking at 60), the deepening of expectations of a rate cut and confirmation of the soft landing scenario in the United States have enabled global equities to rise by 4.3% over 3 months and by 10% since the trough of 5 August. Note that this rise includes the impact of the Fed’s 50bp easing, a major support factor for equities assuming no recession in the United States. In local currency terms, the S&P 500 is up 4.1% over 3 months, compared with just 1.2% for the Eurostoxx and 0.6% for the CAC 40, which is still bearing the scars of the sell-off. In common currency terms, however, performance over the period was virtually equivalent. Elsewhere in the world, the Japanese Topix finished down (-4.1% over 3 months), penalised by the sharp rise in the yen. Against an apparently favourable backdrop of easing global financial conditions, the emerging markets disappointed overall: -0.9% for the MSCI Emerging Markets in currencies, despite a clear outperformance by Brazil. The MSCI China, on the other hand, fell sharply again (-5.1% in dollars), penalised by the slowdown in activity and the lack of a fiscal response from the authorities.
On the commodities market, despite the continued rise in gold and the recovery in agricultural commodities at the end of the period, prices have fallen overall over the last 3 months, largely penalised by the price of oil. Brent crude fell by almost 20% from its peak in July to its mid-September low of 69 dollars a barrel. This fall was mainly due to the slowdown in growth in the United States, but also in China. Since then, the price of Brent crude has recovered to USD 74 a barrel, reflecting the easing of fears about US growth with the Fed’s proactive 50bp cut, and rising tensions in the Middle East between Israel and Hezbollah. Gold, on the other hand, has risen almost constantly, by 11% over 3 months and 25% since the start of the year, reaching new all-time highs in nominal terms and returning to its peak of the early 1980s in real terms at almost USD 2,600 an ounce. There are many reasons for this rise (falling real interest rates and the dollar, continuing geopolitical uncertainty, purchases by central banks and Chinese households).
Key points to watch over the coming months
For the time being, we do not see any major risks to the cycle, but over the next 3-6 months, the market will move back and forth between the soft-landing scenario and that of a sharper slowdown. For its part, disinflation will continue, fairly clearly in the United States and more laboriously in Europe.
On the monetary front, expectations are now well integrated, which limits the risk of surprises. Expectations for rate cuts appear to be moderately optimistic in the United States. The opposite is true in the eurozone.
International politics and geopolitics
Of course, the US elections on 5 November will be the big event of the 2nd semester. In particular, we will need to pay close attention to the composition of Congress. Let’s not forget that most decisions, with the exception of foreign policy, trade policy, part of immigration policy and defence policy, require its approval. As things stand, it appears to be very close, although the Democrats in the House have made a comeback in the polls since Biden withdrew. Historically, votes in the House and the Presidential election have often gone in the same direction. Overall, Harris is more the candidate of the bond market than the equity market. Her election would also probably result in a slightly weaker dollar (more rate cuts by the Fed against a backdrop of budget deficit reduction). Finally, for a European investor, a Harris election would be less unfavourable in relative terms to European equity markets than a Trump election, because of the absence of any increase in tariffs.
In France, although uncertainty has eased with the appointment of Mr Barnier as Prime Minister, it remains sufficiently powerful to fuel the French risk premium. Indeed, the political landscape is highly fragmented, with discussions on the budget due to begin in early October.
And this against a backdrop of a marked deterioration in public finances (public deficit of 5.5% of GDP in 2024, i.e. an effort of 110 bn to bring the deficit down to 3% in 2027, assuming nominal growth of 2.7% and an apparent interest rate of 2%) and the real risk of a downgrade of France’s sovereign rating by Fitch and Moody’s on 26 October (29 November for S&P, which had downgraded France’s rating from AA to AA- at the end of May/beginning of June). In short, the French risk premium appears to be sustainable. We should not expect it to return to its 2016-2019 levels, and the risk remains asymmetrically bullish in view of the current OAT-Bund spread, which at 74bp remains at the lower end of our reasonable estimate range of 70bp-90bp.
On the geopolitical front, tensions, whether commercial and/or military, are set to persist and probably intensify.
- trade tensions with China are set to intensify both in the United States (particularly if Trump wins, with a potential increase in customs duties to 60%) and in the eurozone
- the war in Ukraine shows no sign of ending soon
- a possible intensification of tensions between Israel and Iran, which the market is not taking into account (although we still do not believe that this will have a major impact on oil prices and hence on business)
On the financial markets, despite the Fed’s proactive action, which is undoubtedly favourable to risky assets in the absence of a recession, growth close to potential poses a greater risk of volatility for equities (soft landing or not so soft landing).
In the short term, yields across the yield curve have already fallen sharply. Expectations of cuts in short-term rates in the United States seem optimistic (almost 3 cuts are still envisaged between now and December, with 40% expecting a 50bp cut next October). The risk is of a slight upward repricing in our soft-landing scenario. Beyond that, the trend remains moderate, against a backdrop of slowing nominal growth.
Equity markets have risen sharply, and valuations have rebounded sharply. Furthermore, EPS expectations for 2025 (15% in the United States and 10% in the eurozone) seem optimistic and are likely to be revised downwards. This is particularly true in the eurozone, where consensus macro growth expectations for 2025 of 1.3% seem unrealistic, but also in the United States, where a victory for K. Harris will be accompanied by a risk of fiscal tightening.
What about tech? Caution in the short term, even if the long-term outlook remains buoyant. EPS expectations for 2024 and 2025 remain high (around +20%) and are likely to be revised downwards, as investors have probably overestimated the short-term impact of AI on corporate earnings (other than chip manufacturers) and the macro cycle is slowing. As a result, despite the fall in US real interest rates and the Fed’s easing of policy, valuations (PE at 26.5x) are still too high given the risk factors: the risk of increased regulation, regardless of who wins the US presidential election (slightly more measured if Trump is elected) and the tax risk if Harris is elected (increase in the tax rate on foreign profits to 21%).