FJP - Asset Allocation Committee Outlook Q3 2024: Policy And Politics

2024-07-18 14:50:00 ET

Summary

• We are concerned that the U.S. Federal Reserve may wait too long to follow other major central banks in making its first cut.
• We think political and market volatility is likely to rise in the second half of the year, with the potential to persist well into 2025.
• We think the fundamental economic outlook is clearer and more reassuring than it was three months ago.

Commentary

Over the past three months, the Asset Allocation Committee (the “AAC”) views have coalesced around a core economic scenario of lower inflation, lower rates and positive growth—all of which we regard as supportive for risky and cyclical assets. At the same time, however, we see the risks to the core scenario becoming more pronounced, particularly over the coming months. Those risks have two key sources: the imminent turn in the monetary policy cycle and heightened political uncertainty. As we move from a regime of peak rates to one of declining rates, the risk of a policy error rises: in particular, we are concerned that the U.S. Federal Reserve (Fed) may wait too long to follow other major central banks in making its first cut. On the political side, elections in India, Mexico and South Africa have already generated meaningful localized volatility; and the quarter began with a highly consequential and surprising French election, itself called due to a hard-right surge in the vote for the European Parliament in June. Furthermore, longstanding geopolitical hotspots—Ukraine, the Middle East, the South China Sea—show little sign of cooling. With four months to go until the U.S. elections, we think political and market volatility is likely to rise in the second half of the year, with the potential to persist well into 2025. These risks prevent the AAC from taking a more overweight view on risk assets despite the supportive fundamental economic outlook, and keep us focused on quality investments and portfolio balance.

The Fundamental Outlook is Clearer

We think the fundamental economic outlook is clearer and more reassuring than it was three months ago. Recent weeks have seen significantly cooler U.S. inflation and labor market data, suggesting that the first quarter was a blip rather than something more persistent. If that raises concern about the resilience of current growth, it is worth noting that declining inflation and lower rates would be of greatest benefit to the “have nots”—whose tightening purse strings represent the biggest threat to growth. As one Committee member observed, a major risk to the economy is the recent decline of U.S. real disposable income growth from more than 5% to around 1% per annum. In other words, the big risk to the economy has not been a toss-up between sticky inflation or stalling growth, but sticky inflation leading to stalling growth. By arresting the decline in disposable real income growth, especially among lower- and middle-income groups, lower inflation and rising real wages could provide renewed support for the economy.

Easing Inflation Could Arrest the Decline in Real Disposable Income Growth

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