The US, Europe, China and the rest of the world are moving in different directions.
There have been positive economic surprises from the US, while Europe and China were more muted. Labour demand in the US remains above supply, though it is rebalancing. The ISM Manufacturing Index has contracted for 10 months, while the Services PMI expanded due to strong consumer spending.
Recent jobs data will fuel inflation, so interest rates need to stay at their neutral level, which is hard to ascertain. However, US inflation is likely to fall. The Federal Reserve splits inflation into three: goods, shelter, and services ex-shelter. Goods inflation is above trend but falling; asking rents, now flat to falling, are a forward indicator for shelter inflation, which lags; while services are a function of wages, and wage growth peaked at 7% in 2022, and is now 4.5%. Job openings and quits rates have softened.
For a soft landing, central banks need to get monetary policy exactly right. The Fed forecasts a 4.1% peak in unemployment and a half-point rise in the unemployment rate. Yet its own rule book says such a rise causes a recession. Previous cycles have lifted the unemployment rate by 280 bps on average, not 50 bps. It would be unprecedented for a 500bps hike not to prompt recession.
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Recession in the US remains likely, much more so than in Europe. We think European equities may once again outperform the US. Download our full European Macro Update for October 2023 to learn more.