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15 Dec 2023

The ‘soft landing’ consensus has grown overpowering.

The belief among investors that the Federal Reserve would cut rates aggressively in 2024, even in the absence of a growth or employment shock had become near-universal even before the central bank’s decisively-dovish pivot at the December policy meeting. Inflation is fading quickly. Energy and manufactured goods prices are still coming down, and our estimates suggest that the Fed’s preferred measure—the core personal consumption expenditures index—rose less than 2 percent on an annualized basis over the six months ended in November. Unemployment rates remain near historic lows. With the legacy of a three-year surge in deficit spending and credit growth...

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US economic outperformance is likely to fade.

Markets risk turning overoptimistic on underlying trends: Fiscal support is turning negative, consumer spending is running on fumes as savings rates run well below, and pre-pandemic norms diffusion indices are pointing to a renewed rise in unemployment rates. Non-farm employment diffusion indices, share of industries reporting growth (unchanged cut by half) As the lagged effects of monetary tightening become increasingly evident in rate-sensitive sectors, we expect recessionary headwinds to grow stronger, culminating in a downturn beginning before June 2024. Warning signs should multiply in the coming months, with economic surprise differentials narrowing against the US. GDP-weighted economic surprise indices

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Recession risks remain significant.

The British industrial sector remains mired in contraction, house prices are falling, labour markets are softening, and a broad array of underlying growth indicators are pointing to slowing momentum. With the full impact of higher policy rates yet to hit home, most forecasters currently expect the economy to exhibit stagflation-esque characteristics in 2024 – consensus estimates show inflation topping 3.1 percent while a mild, front-loaded recession leaves growth below 0.4 percent by year end. 2024 consensus forecasts, averaged across data providers

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The euro area is coming in for a hard landing.

A series of data releases in December showed growth slowing more aggressively in the early fourth quarter as activity in the manufacturing and services sectors weakened. The decline in year-over-year data appears consistent with a recessionary downturn.  Citi Economic Data Change Indices To some degree, the economy is suffering from lagging effects associated with last year’s energy shock, exposure to a softening global industrial cycle, and the early stages of fiscal consolidation. But to a significant extent, the euro area’s slowdown looks policy induced. 

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Disinflationary forces are growing more powerful.

The global inflation shock is fading fast. After soaring for the better part of two years, food- and energy-driven headline price measures are coming down more quickly than expected, and core inflation rates (i.e., excluding food and shelter) have tumbled across all major developed economies. With supply chains now largely repaired, Western consumer demand slowing, and the Chinese government pouring stimulus into the manufacturing sector, prices are falling for internationally-traded goods. At the same time, a weakening global demand outlook is intersecting with surging non-OPEC production to put oil benchmarks – critical in driving consumer inflation expectations – under sustained...

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