The neither hot-nor-cold Goldilocks era of sustained moderate economic growth combined with low inflation and benign monetary policy is drawing to a close, warns Robeco.
In addition to declining consumer spending and corporate investment, the impact of continuing high interest rates may trigger unemployment rising to 1-2% towards 2025.
“Contrary to market expectations, the US economy has shown surprising resilience in 2023, characterised by low unemployment and disinflation,” said Peter van der Welle, multi-asset strategist at Robeco.
“Yet, the last mile for central banks will prove the toughest. Further disinflation efforts (in the US and Eurozone) will come at a higher cost as the trade-off between unemployment and inflation steepens at lower levels of inflation,” he said.
“The current consensus narrative suggests a soft landing, where inflation is controlled without significantly increasing unemployment. But we believe this is overly optimistic.”
Yet, corporate and housing balance sheets are still robust, preventing a classic recession so far. China, on the other hand, is grappling with the risk of outright deflation, and a further downward trend in home sales and house prices in China could hinder a sustained domestic consumption recovery, warned Van der Well.
Meanwhile, the geopolitical landscape in 2024 is complex, with important elections in the G7 countries. Ongoing conflicts and a fractious relationship with China contribute to a fragmenting world order, increasing economic policy uncertainty.
AI adoption is seen as a potential solution for improving productivity and reducing unit labour costs, noted Robeco. However, the supply-side potential from AI adoption has not yet translated into improved productivity figures.
Vulnerability of markets
In terms of asset allocation, bond yields might not have peaked, initially affecting their use as a hedge, according to Robeco. “Yield curves could steepen more due to fiscal worries, though bond-equity correlations will likely turn negative when core inflation drops below 3%.”
Equities also face challenges, such as decreasing liquidity, geopolitical issues, and high interest rates.
“Current double-digit earnings growth projections by consensus look rather upbeat, which may trigger multiple compression,” said van der Welle. “While consensus earnings forecasts carry downside risks, Europe and Japan might fare better.”
In the currency market, the US dollar’s high valuation may have reached a peak as the US Federal Reserve approaches the cutting phase of the cycle. “The dollar-yen pair is interesting due to the yen’s potential to rise,” he said.
Finally, given the significant tail risk of oil prices remaining elevated for longer in 2024 despite weakening growth, the inflection point in the performance of sustainable funds may not yet happen in 2024.