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Eddy's weekly market insight

Friday, 07 June 2024

In our previous reports, we have mentioned it several times already: Since the beginning of 2022, interest rates in the West have risen at a record pace. Normally, this is enough to cause a rapid slowdown in economic growth, if not a recession. This was also expected by most economists for the second half of 2023. Indeed, growth in Europe has significantly fallen back, but in the US, it averaged around 4% in the second half of 2023. Subsequently, growth in the US declined to about 1.5% in the first quarter of this year, but this was mainly due to a number of one-time factors. Underlying growth was still around 3%. In Europe, growth even picked up from 0% to about 1%.

However, from early May, the figures, especially from the US, began to weaken clearly. Economists and markets responded by saying: "The high interest rates are indeed slowing down the economy, only this time the time lag is longer than usual." But is this really the case? Last Friday, quite strong employment figures….. 

came out of the US, and the latest estimates for growth in this quarter are just below 3%. Also, recent figures from Europe have been better. This means that, at the moment, growth in both Europe and the US is too high to structurally reduce inflation below 2%. This raises two important questions:

  1. What can be expected in terms of economic growth, wage increases, and inflation in the coming period?
  2. What will central banks do with interest rates going forward?

It is important to realize that central banks must maneuver very carefully. If they keep interest rates high for too long, a recession will follow. However, this could easily lead to a new credit crisis, which would be very difficult to combat this time.

The still ample monetary conditions continue to significantly stimulate growth. As long as this persists, we see growth, wage increases, and inflation only slowly decreasing. Interest rates may still fall a bit, but at a slow pace (no more than 0.25% per quarter for the time being). The ECB has already taken a first step, likely only because this was announced well in advance. The interest rate has now been lowered, while the bank itself has just raised its growth and inflation forecasts to levels above the target. This limits the scope for further rate cuts in the future.

It could also indicate that central banks are so fearful of a recession that they do not want to risk falling into one just to bring inflation from just below 3% down to 2%. After all, an inflation rate of 3% is not that bad. This dilemma will become much more serious in the coming years anyway, as government deficits continue to rise, driving up inflation and interest rates. We suspect that central banks will increasingly choose not to let interest rates rise too much (this would also be very detrimental to public finances) and to accept that inflation will rise.

We currently give this scenario more than a 50% chance, which would be negative for stocks and bonds in the longer term, and positive for precious metals.

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