Outlook Overview: Rate Cuts But How Far?

·        The U.S. economy is slowing, with the critical question being whether this is a soft or harder landing.  Our broad analysis leaves us inclined to the soft landing view into 2025, though we shall watch real sector data closely over the next 3-6 months to check the trajectory.  Elsewhere, European growth should recover into 2025 from a weak 2024, but be modest rather than a strong recovery. Finally, we forecast that China growth is set to slow to 4% in 2025, as a slowdown in consumption adds to the drag from the residential property sector.  This all means growth worries, before a modest recovery into H2 2025.

·        For DM central banks this means reducing the degree of policy restriction consistently, given that inflation is heading back to or close to target in most countries.  The Fed will likely ease to a 3.00-3.25% Fed Funds rate by end 2025, with a further 125bps also delivered by the ECB.  In contrast, the BOJ wants to normalize further and we see a further 75bps of hikes by mid-2025.

·        For EM central banks, the Fed easing and a soft USD landscape allows scope to reduce interest rates, where domestic inflation is heading towards target.  Mexico, India, Indonesia and South Africa will likely ease, but by less than the Fed given less their own central bank policy assessments and in most cases less of an economic slowdown than the U.S.  Meanwhile, Turkey and Russia are dependent on domestic inflation trajectories and Brazil is doing a mini tightening cycle but will likely resume cuts in 2025.  China will likely cut the 7-day reverse repo rate by a further 20bps by end 2025 after the Sep 24 cut (here) given economic and inflation weaknesses, but is unlikely to go to ultra-low interest rates or use QE due to opposition from China’s authorities.

·        On the political front, the outcome of the U.S. presidential election is key and the race is currently too close to call.  If Kamala Harris is elected, then it would likely herald a broad continuation of existing policies.  If Donald Trump is elected, then we feel his key priority would be immigration (where he could threaten Mexico) and renewing the lapsing parts of the 2017 tax cuts.  However, 2025 could also see Trump stopping funding to Ukraine to force a negotiation between Ukraine and Russia to end the war.  Trade threats against China in 2025 would also likely come from Trump, but we feel a trade war is more likely in 2026.  Elsewhere, a wider Middle East war is unlikely, though Israel/Iran and Hezbollah could exchange more missile strikes.  An end to the military phase in Gaza could be seen in 2025, but progress to a two state solution will likely be very slow.

·        For financial markets, the DM easing cycle has been largely discounted in the money market curves, but 2yr government bond yields can still come down as the actual easing arrives and stability becomes factored in for policy rates in 2026. 10yr U.S. yields will likely be choppy and consolidative for the next 15 months, thus we see modest yield curve steepening.  For equity markets, the U.S. will likely be at risk to the downside in the next 3-6 months, as the soft vs hard landing debate will linger and 2025 corporate earnings get cut. We favor outperformance by the UK and EM Asia ex China by end 2025.          

·        Risks to our views: DM countries could see stronger lagged effects on the economy from the 2022-23 monetary tightening that could mean a stalled recovery in the EZ/UK or more of a slowdown in the U.S. economy.  The Fed could then cut to 2.00% (here).  Separately, in China the impact of the residential construction decline/consumer slowdown could be stronger than expected in economic and financial instability terms and cause a harder landing around 3% growth for China (here)  This would negatively affect EM economies (Figure 1).