Autores
Seema Shah
Chief Global Strategist
Brian Skoypec, CIMA
Director, Global Insights &
Content Strategy
Benjamin Brandsgard
Insights Strategist
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Key themes
Hover over each tile to read more about this quarter's key themes.
The U.S. economy stands out from the crowd.
Key takeaway
The U.S. is set to outperform its global peers once again. While Europe struggles to make signficant headway, the U.S. economy is heading for a soft landing.
The U.S. economy has withstood the most aggressive central bank rate hiking cycle in four decades and continues to grow strongly, overshadowing other major global economies. In the second half of 2023, the U.S. economy posted an average quarterly GDP growth rate of 4.1%. By contrast, the UK entered technical recession, while the Euro area remained entrenched in a state of stagnation.
Looking forward, Europe is seeing signs of a cyclical upturn in the manufacturing cycle and should avoid recession, while Japan’s reflation story has legs. U.S. growth is set to cool over the coming quarters as consumers pull back slightly, the labor market rebalances, and corporates finally confront higher refinancing costs. But overall, growth will likely only slow to trend, with 2024 marking another year of U.S. economic outperformance.
Global growth
Quarterly, 4Q 2022 - 4Q 2023
Source: Federal Reserve Bank of New York, Bloomberg, Principal Asset Management. Data as of March 31, 2024.
Global inflation: A frustratingly slow last mile
Key takeaway
The last mile to central banks’ inflation targets is proving tough and may require some (small) cracks in the labor markets to materialize.
Global disinflation has made significant headway, and generally without job losses. However, there are now signs that inflation is no longer decelerating. Recent U.S. inflation prints represent a setback in the Fed’s effort to build additional confidence in the sustainability of disinflation. While core goods inflation has dropped sharply, driven by normalizing supply chains, core services inflation ex-housing—the segment of the consumer basket most closely related to the labor market—remains strong, raising concerns that the U.S. labor market is simply too hot to permit inflation to reach the 2% target.
In the UK and the Euro area, central banks are closely focused on wage growth. Lackluster economic activity suggests wage growth is likely to weaken, but clear evidence is necessary before both central banks can begin executing rate cuts. By contrast, for the Bank of Japan (BOJ), the “shunto” wage negotiations, which showed stronger-than-expected wage growth, were the final piece of the inflation puzzle to convince the BOJ to shift away from negative rates.
GDP-weighted inflation
January 2007 - present
Source: Bloomberg, Principal Asset Allocation. Data as of February 29, 2024.
Global central banks: More reason to cut than the Fed
Key takeaway
Global central banks would prefer to start cutting rates at the same time as the Fed. Yet their weaker economies mean they will move with greater urgency. Their relatively dovish policy path will keep upward pressure on the U.S. dollar.
Typically, as the largest economy in the world, the U.S. sets the stage, and global central banks wait for a signal from the Fed before they begin their easing cycles. Yet the European Central Bank (ECB) and the Bank of England (BoE) are struggling with weak economies and have a clearer need to loosen monetary policy than the Fed. They too are waiting to gather sufficient evidence of sustained disinflation before they enact a rate cut.
We expect the ECB rate cutting cycle to be delayed until June and, for the BoE, potentially late summer. However, both central banks will be uncomfortable starting their cutting cycles several months ahead of the Fed.
Once they do start cutting rates, the BoE and ECB are likely to move with more urgency than the Fed as they are facing a greater risk of protracted economic downturns. As a result, the U.S. dollar will likely see an extended period of strength, only slightly muted by the Bank of Japan’s policy moves towards a more restrictive setting.
Global central bank rates
January 2021 - present, forecasted through 2025
Source: Federal Reserve, European Central Bank, Bank of England, Principal Asset Management. Data as of April 10, 2024.
Equities should continue embracing the soft landing narrative.
Key takeaway
Equity markets are facing a goldilocks combination of a soft landing and rate cuts. This should support a broadening of the market rally to other more cyclical sectors.
Central banks have fueled a market rally as they embrace optimism about inflation without sacrificing growth. Historically, when central bank easing takes place against a backdrop of a soft landing (like in 1995) the economy enters a mid-cycle position—whereby growth is stimulated by rate cuts, extending the economic expansion, the earnings upswing and, therefore, the market rally.
The Magnificent 7 should extend their positive performance. After all, the strong balance sheet characteristics and secure competitive market positions of the Magnificent 7 imply that a significant correction is unlikely, despite their valuations drawing comparisons to the 2000s tech bubble. Yet, this year, the combination of a soft economic landing and rate cuts should see strong performance broadening to other more cyclical sectors and markets whose valuations are not quite so stretched.
The stock market and earnings
S&P 500 Index price and trailing earnings-per-share, 1990-present
Source: Clearnomics, Standard & Poor’s, Bloomberg, Principal Asset Management. Data as of March 31, 2024.
Fixed income: We’re here for the carry
Key takeaway
Although credit spreads remain tight, the fixed income asset class is offering important carry opportunities. Concerns around the high yield maturity wall are likely overblown.
The combination of solid economic growth and a Fed that is clearly keen to cut policy rates has solidified a constructive backdrop for credit.
Spreads are historically tight for both investment grade and high yield credit. Yet, while spreads may not tighten significantly from here, provided the economy does not deteriorate significantly, they should not widen much either. More pertinently, credit is offering important additional carry to U.S. Treasurys, while the total yield available in fixed income is also attractive compared to equities.
A much-flagged risk for high yield this year is that the wall of maturing debt will face significantly higher refinancing costs, potentially triggering a spike in defaults. However, the resilient macro backdrop and strong balance sheets suggest that companies should scale the wall relatively unscathed.
Yield comparison: High yield bonds, investment grade bonds, U.S. Treasurys, and S&P 500
High yield bond yield-to-worst, investment grade bond yield-to-worst, U.S. Treasury yield-to-worst, S&P 500 12m forward earnings yield
Source: S&P Dow Jones, Federal Reserve, Bloomberg, Principal Asset Management. Data as of March 31, 2024.
The wall of cash is looking for a new home
Key takeaway
Money market funds have surged in recent years but, in 2024, with rate cuts likely and the economy still on a positive path, risk assets should perform strongly, and cash is set to lose its attractiveness.
Assets in money market funds have ballooned to a record $6 trillion, with investors attracted by elevated yields and partially hiding from an uncertain U.S. economic outlook. Many of the concerns and questions of recent years should finally be resolved over the coming months. The economy is slowing but is on course for a soft landing, earnings growth will likely remain positive, and, most importantly, the Fed is on the verge of rate cuts, reducing the attractiveness of cash.
Non-cash assets can deliver solid returns and provide important diversification in portfolios. In the base case scenario, a soft landing, risk assets like equities should outperform. If, however, this is too optimistic and recession materializes, bonds can offer stability and a hedge against the downside risks. If inflation resurges, alternatives such as real assets can outperform. Investors should be prepared: Rate cuts should ignite a surge in sentiment—and there’s a massive $6 trillion mountain of cash to fuel the resulting rally in risk assets.
U.S. total money market fund assets
Trillions, 2000-present
Source: Federal Reserve, Investment Company Institute, Bloomberg, Principal Asset Allocation. Data as of March 31, 2024.