Inflation still challenges the interest rate outlook

Economic supply versus demand imbalances have continued to unwind post-pandemic, tough year-on-year comparable have helped the maths, and the rapid hikes from central banks have started to bite. Going forward however, getting inflation rates all the way down to target, especially without an outsized negative impact on economic growth may prove to be much harder. 

Inflation continues to be multifaceted, and adverse inflation inflexion risks worried the market during Q3 in particular. Energy prices which had initially dragged inflation rates lower earlier in the year, started to move higher over the summer. This was driven by a relatively constructive global energy demand picture on the one hand, versus voluntarily extended crude oil supply curbs from Saudi Arabia and Russia on the other. While core consumer gauges (which exclude energy and food prices) still generally moved lower during Q3, should higher oil prices prove to be more of a sustained feature, this could ultimately filter through as a headwind for many economies. Neither is the inflation picture uniform globally, with very different messages between the world’s two largest economies. While US consumer inflation remains some way above the 2% target, China instead spent Q3 flirting with outright annual deflation risks. 

For most advanced economies, if Q3 has generally been a story of stickier inflation, the flipside is that this has in part been the result of more resilient economic growth, at least as far as relative to expectations – in July the International Monetary Fund upgraded its estimate for calendar Real (constant prices) Gross Domestic Product (GDP) global growth from 2.8% to 3% in 2023, with an unchanged 3% growth estimate to follow in 2024. With labour markets still comparably tight, and annual nominal wage rates starting to edge over inflation, a consumer that is still able and willing to spend has helped companies continue to post solid earnings results and outlooks. As a result, global recession fears have been pushed back, but questions remain whether this is a global recession that has been cancelled, or merely just one that has been delayed. Perhaps not surprisingly, markets have been skittish, continuing to move back and forth between the ‘no recession and soft-landing’ camp (where interest rates curtail inflation without unduly impacting economic growth), and the ‘recession and hard-landing’ camp during Q3. 

The inflation picture continues to lead the actions for central banks and dominate sentiment for markets. Sticky inflation remains a risk, whether brought about by resilient consumer demand or a resurgence in cost-push inflation via the energy market. This might lead to a longer period of peak interest rates, in turn weighing more on economic growth. Equally, should inflation fall sufficiently quickly, this would give central banks the confidence that they can ease monetary policy settings and language and still see inflation settle around their target levels. Financial markets meanwhile do not operate in a vacuum – following a more constructive consumer and business picture relative to what had been feared at the end of last year, equity valuation multiples so far this year have recovered some of their 2022 full-year downdraught and globally are back around their longer-term average. 

As we weigh up this nuanced investment outlook, the challenge for asset allocation is how to take a calculated position so that we keep exposure towards more than one economic scenario materialising. The following pages outline how we are well-positioned, staying invested and keeping balance, as we seek to help you our clients target your own investment goals.

All articles in the Quarterly Market Overview Q3 2023

Introduction
United Kingdom
United States
Europe exc. UK
Asia Pacific (exc. Japan)
Emerging Markets
Outlook