Monetary Policy
In Section I, we examine some concerning signs of US economic weakness that emerged in June. We also discuss portfolio positioning in the face of falling interest rates and cross-check our recommended US equity overweight in the face of extremely optimistic expectations about AI’s impact on growth. We conclude that defensive positioning continues to be warranted. In Section II, we dig into those optimistic expectations for AI. We find that the US equity market is significantly overvalued unless the deployment of AI technology causes a 10-to-20 year productivity surge in line with what occurred during the IT revolution of the 1990s, with persistently high margins on the revenue generated from the improvement in growth. We doubt that AI will end up truly boosting economic activity by this magnitude.
We look at the implications a various European central bank meetings this week, for currency strategy.
Europe did not witness a major policy reversal. Inflationary pressures are coming down, enabling the ECB to cut rates and European states to maintain soft budgets. Geopolitical challenges ensure that European parties continue to cooperate on national defense, economic security, and energy security.
Investors should prepare for economic data to weaken even as policy uncertainty and geopolitical risk skyrocket ahead of the US election.
The UK labor market remains far too tight to expect wage growth to slow to levels consistent with the Bank of England inflation target. A true recession with rising unemployment is needed to finally slay the UK inflation beast. 2024 rate cuts are off the table, with the central bank having to keep monetary policy tighter for longer than markets expect and the UK economy now rebounding. We recommend downgrading UK gilts to underweight in global bond portfolios, while also looking for opportunities to buy the British pound on pullbacks versus the euro, Canadian dollar and Swedish krona.
In the short run, global risk assets are vulnerable due to rising oil prices and bond yields. Cyclically, a global economic downturn will weigh on global risk assets.
At today’s monetary policy meeting, the ECB gave strong hints that rate cuts will begin as soon as the next meeting in June. In this Insight, we share our thoughts on today’s meeting and discuss the implications for European bond yields and the euro.
Despite a couple of rate cuts in H2 2024, borrowing costs will remain elevated in real terms amid lower inflation in the US and Europe. This and tightening fiscal policy will hinder domestic demand in advanced economies. Domestic demand in China and EM ex-China will remain very tepid, with risks skewed to the downside.
We expect oil-demand growth to increase this year – to 1.7mm b/d from 1.4mm b/d (0.30% of total demand) – and anticipate tighter supply at the margin. Our balances estimates are unchanged, leaving our Brent price forecasts for 2024 and ’25 at $95/bbl and $105/bbl. We expect the US to deploy warships if Venezuela makes a move on Guyanese territory in a bid to grab deep-water oil production.
The Bank of Japan delivered a historic policy adjustment this week, ending both negative interest rates and Yield Curve Control. In this Insight, BCA’s global fixed income and currency strategists discuss the immediate implications of the move for Japanese bond yields and the yen, and the potential for additional tightening actions.