Surprise, surprise – The global economy forges ahead

The first quarter of 2024 has surprised on the economic front. Instead of the anticipated slowdown, coupled with US outperformance ending, what we saw was global economic activity picking up and stronger-than-expected global growth. The US posted better-than-expected Q4 2023 GDP figures and positive manufacturing and services surveys. The big surprise was that other developed markets, like Europe, joined the US in posting stronger economic data, signalling a rebound from the recent downturn.

The better economic data increased investor optimism, resulting in another positive quarter for risk assets. Developed markets, led the US and Japan, saw significant equity gains further bolstered by strong corporate earnings. However, the sting in the tail of the better economic data was signs of inflation remaining stickier than desired. This led to a drastic reduction in rate cut expectations, particularly for the US Federal Reserve, leading to negative bond returns. While bonds face challenges, the global equity outlook remains positive due to economic strength and the potential of a “no landing” scenario with more modest monetary policy easing.

In Australia, the picture is more mixed. Despite a more robust-than-expected labour market and upcoming income tax relief, household consumption remains weak, with only a modest recovery projected in 2025. Australian aggregate demand and CPI inflation have moderated, with inflation declining from 7.8% in Q4 2022 to 4.1% in Q4 2023 as well as in the monthly CPI prints in the first quarter of 2024 with 3.4% (annualised) reported for February.1 However, the RBA (Reserve Bank of Australia) is not satisfied yet and has maintained high interest rates to combat inflation. The high interest rates are also impacting demand leading to a slowdown in real GDP growth. Despite this nascent weakness, the RBA is expected to delay interest rate cuts, prioritising inflation control. This stance, coupled with weak consumer sentiment, signals a challenging economic outlook.

Figure 1: Consumer Sentiment Weak Despite Strong Labour Market

A surprising divergence has opened up between employment and consumer spending. Employment expectations are in good shape but constrained consumer sentiment has fallen to recessionary levels. This divergence suggests underlying structural issues which could be explained by the recent spike in inflation and the cautious stance on purchasing major household items. Another explanation is that after the “revenge spending” in 2021 and 2022, consumers are looking to replenish savings.

The upcoming stage-3 tax cuts are a significant fiscal impulse for the second half of 2024 and may distort the path of inflation returning to the RBA’s target band. However, given that the outlook for consumer spending is still benign, households may use the tax break to further replenish savings. The RBA has remained confident that inflation will return to the target band in the medium term. We expect CPI to average 3.3% in 2024 and then decline to the target band at 2.7% in 2025. Further disinflation progress this year could mean the RBA will be happy that the job is done and will allow it to cut rates.

We think the RBA will be one of the last major central banks to cut rates, as they wait to assess the impact of the sizeable fiscal stimulus via tax cuts. Furthermore, Australian consumers have been managing higher mortgage rates quite well. The RBA’s Financial Stability Review (FSR) found that only 1% of borrowers are in negative equity, and that the majority would be able to service their debt even if interest rates rose by a further 50 bps.2 We expect two interest rate cuts from the RBA in 2024 with the first rate cut coming in either August or September. As highlighted in our previous commentary, the key risk to the outlook for Australia is the RBA delaying rate cuts to the point when it’s clear the economy needs them.

The current market environment is characterised by Australian equities and global risk assets at record levels with stretched valuations while fixed income suffers occasional bouts of weakness due to stubbornly high inflation. For investors not willing to so easily shrug off the multitude of risks on the horizon like policy shifts, persistent inflation, and geopolitical tensions, a compelling case can be made for an allocation to gold. Despite its lack of cashflows and associated holding costs, gold offers protection against market uncertainty. Gold has demonstrated performance on par with equities over the past five years, which have been marked by uncertainty. Historical data reveals a negative correlation between gold and equities, with gold typically outperforming during times of crisis. This highlights gold's potential as a critical diversifier in investment portfolios. Given the prevailing risks, gold provides a prudent hedge against economic vulnerabilities especially as the inflation outlook remain cloudy.

Figure 2: Average Weekly Returns During Periods of Elevated Volatility

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