Economic Outlook

• Uncertainty about when the US Federal Reserve (Fed) would begin its rate-cutting cycle - and the pace at which it would likely proceed- kept the fixed income markets on edge throughout the summer.
• Fears that the Fed had waited too long to cut rates, potentially triggering an imminent recession, weighed on investors.
• The Fed ultimately followed a more aggressive path, initiating its rate-cut cycle with a 50bps cut.
• However, it's unlikely that this is the start of a new pace of rate cuts. The Summary of Economic Projections (SEP) is consistent with a downshift back to 25bps cuts at the November and December meetings.
• Leaving rates unchanged for most of 2024 as inflation fell effectively tightened monetary policy, contributing to rising downside risks.
• Nevertheless, a recession does not seem imminent. Robust domestic demand has continued to support the growth in US economic activity.
• In Europe, GDP growth remains anemic. Falling inflation provided the European Central Bank (ECB) cover to start its ratecut cycle in June, earlier than the Fed. After the initial 25bps cut, the ECB waited until September for the next rate decrease. More rate cuts are anticipated but remain data dependent.
• In Japan, the economy is still feeling the aftershocks following the unwinding of the yen carry trade. The stronger yen is likely to keep inflationary pressures in check, but there are lingering concerns that the Bank of Japan will revert to its old habits of tightening monetary policy too aggressively and too soon.
• The People's Bank of China has cut rates several times this year, but that has yet to turn around slowing economic growth in China.

Market Outlook

• As we approach the final stretch of 2024 and start the run-up to the US presidential election, global financial markets continue to evolve.
• The third quarter saw a continuation of the risk-on theme evident in markets for much of this year, marked by a spike in volatility driven by US recession fears and the yen carry trade unwind.
• Still, as much as the first half of 2024 was marked by low volatility and strong gains in risk assets, the sudden flare-up in risk aversion in July and August set the stage for continued market volatility in the near term, until at least the US election is over.
• Historically, equity markets have turned in muted performance in the run-up to elections, followed by a post-election relief rally. With stocks already booking strong year-to-date gains, fundamentals might be a bigger market driver, together with election-related policy uncertainty.
• The stocks-bonds yield gap is well below its 30-year historical average of 2.6%, suggesting an unfavorable risk-return profile for stocks relative to bonds.
• Strong stock returns going forward depend on significant earnings growth improvement and valuation multiple expansion, which are less likely in the near term.
• For fixed income, the steady moderation in economic growth along with rising confidence that core inflation is easing has resulted in a sharp drop in the 10-year Treasury yield over Q3.
• Rates volatility is likely to persist as markets continue to evaluate the extent of rate cuts, especially given the sustained strength of the economy.
• The environment of moderate growth and inflation along with expected rate cuts will likely be supportive of credit spreads remaining around their current tighter-than-average levels.