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Quarterly Market Outlook: Q4 2023

Difficult balance between growth and inflation

After the steepest interest rate hikes in decades, central banks and markets are shifting their focus from inflation to growth. This dynamic has different speeds, with emerging economies leading and already shifting the focus from inflation containment to economic slowdown. Overall, the effect of monetary tightening on economic activity is occurring more slowly than in previous cycles and this may lead to a period of higher for longer interest rates. The strength of the labor market and generous fiscal stimulus have made this economic cycle more resilient than previous periods of adjustment.

Investors in general, and more conservative investors in particular, may benefit from the resurgence of fixed income as an investment alternative. Interest rates have most probably reached their terminal level and that supports the attractiveness of increasing exposure and duration in bond portfolios. They may also want to keep equity exposure at moderate levels as long as the risk of further adjustment in earnings estimates persists.

01. Focus on inflation in Europe and the U.S.

The market is starting to give a high probability to both the Fed and the ECB have completed the process of interest rate hikes. However, we believe that the focus will remain on controlling inflation for some time and we rule out rate cuts in the short-term.

The Fed cannot yet call the battle over as the fall in core inflation is much more incipient and there is more downward resistance in wages, as seen in the chart to the right. The lagged adjustment in wage inflation is due to a robust labor market that remains at full employment because, as seen in the left chart, the U.S. economy continues to show signs of strength thanks to stable consumer growth.

The Federal Reserve faces a scenario in which the economy continues to show signs of strength despite high interest rates

The European Central Bank (ECB) is facing greater concern about inflation and price dynamics in the Eurozone compared to the United States. The chart on the right shows a significant lag in disinflation trends with a particular focus of concern in Germany. This is why the ECB raised its deposit rate to a record high of 4% at its September '23 meeting, despite signs that monetary tightening is significantly affecting financial conditions. The added concern for the ECB is that the economy is already showing signs of a slowdown, as can be seen in the chart on the left.

The ECB has probably activated the pause in rate hikes, but inflation would not allow it to consider lowering rates in the short term despite the economic slowdown.

02. Focus on growth in emerging markets

Chinafails to meet expectations of a rebound in growth after the reopening. There are concerns about the situation in the real estate sector and the Asian country is once again exporting deflation to the rest of the world. In other emerging economies, central banks have made substantial progress towards their goal of controlling inflation with early and decisive action, as a result, they have already shifted the focus to growth and have started an interest rate cutting phase. This is the case of Chile, Brazil, Peru and Uruguay, as well as Poland.

Other Emerging Economies Central Bank's Focus
Real rates (nominal rates - inflation) have reached very high levels in Latin America. In Poland they are negative due to monetary policy focus on growth.
Real rates (nominal rates - inflation) have reached very high levels in Latin America. In Poland they are negative due to monetary policy focus on growth

People's Bank of China Focus
Weak residential investment is a drag on growth.

The growth model based on residential investment is losing momentum and the consumer is not taking up the baton due to concerns, amongst other factors, about real estate valuations.   

03. Time to lock-in high interest rates

The focus of concern will eventually shift, as a logical sequence, from inflation to economic growth. There are many nuances depending on the geographic area and the maturity of the rate adjustment process, although globally we see greater downside risk in growth estimates than in those related with inflation and interest rates.

  • Our central scenario implies adverse monetary and financial conditions for growth dynamics due to the delayed effect of the rate hike.
  • The scenario we see as most likely is that of a long-landing or prolonged period of below-normal growth that would ensure the return of inflation to levels around the 2% target.
  • When it comes to asset allocation, we see greater risk in the expectations of growth-sensitive assets.


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