Representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets, and economic releases such as inflation, GDP, consumer confidence, housing, retail sales, and job unemployment news. Here is their outlook for the third quarter of 2024.
While many market participants have been focused on the parlor game of guessing the timing of policy rate cuts from the Federal Reserve, we have been taking stock of the broader economic themes playing out and the semblance to the soft landing the U.S. economy experienced in the mid-1990s. Some of the similarities that can be drawn from today’s economy include: robust economic growth driven by strong consumption fueled by rising equity markets, and relatively low unemployment rates that led to technological advances and moreover a prolonged period of increased productivity. We expect the Fed will maintain a watchful eye over inflation in the coming months, but the ultimate legacy for Chairman Powell would be a soft landing in 2025 that is supported by strategic rate cuts into a slowing economy that provides enough stimulus for a stable growth environment for the years to come.
Throughout the second quarter of 2024, growth has indeed remained more resilient than many economists had expected, but the longer the Fed keeps policy rates at the peak, we will likely see further signs of moderating consumption showing up. Most of the economic data surrounding the labor market has remained relatively robust, but there are arguments that seasonality factors have led to misleading data. Last, survey-based data on the economy has been wavering, and the signal of continued strength has not been that convincing. The combination of mixed economic data and less progress on the inflation front has delayed the Fed cuts into the second half of the year, but expect Chairman Powell to ultimately err on the side of caution with regards to the U.S. economy, and look for a gradual rate-cutting process to commence. As such, when you apply the view from 30,000 feet, the current economic backdrop draws many similarities to the 1990s. In conclusion, while the timing of Federal Reserve rate cuts remains uncertain, it is important to consider the broader economic themes at play. Drawing comparisons to the soft landing of the mid-1990s provides valuable insights into the current economic environment, which features robust growth, technological advancements, and a Federal Reserve cautiously guiding the economy toward stable growth.
In 1Q24, real GDP growth significantly decelerated, slowing to an annualized rate of 1.3% compared to 3.4% in the previous quarter. This slowdown can be attributed to various factors including lower consumer spending, an increase in the trade deficit, and a decline in federal government spending. The increasing trade deficit in 1Q had a negative impact of around 1% on GDP growth. While personal consumption has remained strong, there has been a shift toward consumers spending a higher proportion of their disposable income, which has been accompanied by increased levels of borrowing. Also, there has been two consecutive months of disappointing retail sales data. Our growth outlook for 2024 is revised up to 1.5% to 2.5%, reflecting the resilience displayed in the first half of the year. However, caution is warranted as there are indications of a cooling trend as we enter the second half of the year.
As the market's expectations on rate cuts shifted in response to changing inflation dynamics in the first half of this year, the timing of the first full rate cut is currently priced to occur at the December 18 FOMC meeting. Although there has been some mention of the possibility of rate hikes if necessary, the overall narrative from the Federal Reserve continues to emphasize a wait-and-see approach to policy making. Inflation is projected to continue its decline in the second half of the year, led by a decrease in service inflation. Anticipating a prioritization of inflation, the Fed is expected to delay interest rate cuts until later this year or adopt a more irregular approach based on inflation data, while still aiming to maintain a soft-landing scenario for the economy. Consequently, we are adjusting the projected Target Fed Policy rate to finish 2024 between 4.75% and 5.25%, indicating the anticipation of one to two rate cuts by the end of this year.
The first quarter inflation data presented a challenge for the Federal Reserve, raising the question of whether it was merely a temporary bump or a more significant deviation from their expectations. Despite core inflation measures not showing improvement during the quarter and even indicating a possible worsening, the annualized core personal consumption expenditures (PCE) currently stands at 2.75%, falling within our anticipated range for 2024. Additionally, we expect that rent inflation will continue to cool as shelter costs tend to lag behind other components of inflation. Thus, we are maintaining our inflation target of 2.0% to 3.0% for 2024 core PCE inflation.
Given the current market dynamics, it is unlikely that we will see a run back up to 5% in 10-year yields. As past Fed cycles have shown, the 10-year Treasury rates tend to fall leading up to the first rate cut, which reflects a slowing economy. If inflation data continues to improve and broader economic data deteriorates further, rates are likely to decline. However, there are reasons to expect 10-year rates to remain above 4%, including the higher terminal rate that is currently priced in by market participants, and technical supply factors that will persist in the coming years. All of which are likely to bring the return of term premium to the yield structure. Considering these factors, we see more asymmetry in the direction of rates over the medium term, with a greater probability for rates to move modestly lower from the current levels. As a result, our outlook for the 10-year yield is revised to 4.00% to 4.50% by the end of 2024.
Equities are potentially facing challenges in the current environment, characterized by mixed economic indicators, a higher-for-longer Federal Reserve policy stance, and elevated valuations. Valuations have reached stretched levels, with the S&P 500 forward price-to-earnings ratio approaching its peak from August 2020. Despite this, S&P 500 earnings have continued to increase, making equity markets priced to perfection. Heightened uncertainty arising from factors such as the Federal Reserve's actions, geopolitical concerns, and the upcoming U.S. election reduces confidence in predicting a specific range of returns. However, the significant increase in money market assets, which have grown approximately 33% in the past two years to nearly $6 trillion, suggests potential dry powder that investors may deploy. Against a backdrop of moderating growth and tight monetary conditions, our expectation for S&P 500 returns in 2024 remains within the range of 0.0% to +10.0%.
Table Columns
Previous – Observation as of the end of the prior month
Survey – Economist survey prediction for current month’s observation
Actual – Actual observation as of the end of the current month
Next – Date of next period’s observation
ISM Manufacturing Index
Based on a survey from the Institute for Supply Management, this index indicates a positive growth in the manufacturing sector when the figure is above 50 and a contraction of the sector when it is below 50. An increase in the figure indicates either slowing contraction or accelerating growth. The index represents underlying figures in employment, inventories, new orders, production levels, and deliveries. (Source: Bloomberg)
Unemployment rate
Based on a monthly survey of households, the unemployment rate is one of many figures in the Current Population Survey that move markets by indicating what portion of the population is at work, looking for work, what they are getting paid, and how many hours they work. The unemployment rate is the percentage of workers unable to find work who are actively seeking a job. The survey is conducted by the Bureau of Labor Statistics.
Retail sales
Retail sales measure the total amount of purchases by consumers in stores that sell merchandise, food, and other services to end consumers. This measure is a significant indicator of trends in consumer spending, which moves markets because consumer spending accounts for over two-thirds of U.S. economic output. Data is compiled by the U.S. Bureau of the Census.
Consumer Price Index (CPI)
The Consumer Price Index measures the prices of a fixed basket of goods that reflect an average consumer’s cost of living. CPI is a popular indicator of inflation, driving prices on U.S. inflation-linked bonds, and is used to adjust tax brackets and Social Security payments. CPI is compiled by the Bureau of Labor Statistics monthly.
Home Price Index
The S&P CoreLogic Home Price Index is the seasonally adjusted average price of residential homes in 20 major cities in the U.S. Data is published with a two-month lag (numbers available in March reflect price changes from January). Housing prices affect consumer wealth and consumers’ ability to borrow and spend, which in turn affects U.S. economic growth.
Gross Domestic Product (GDP)
Gross Domestic Product is the sum of the value of all goods and services produced in the economy. It is one of the most comprehensive benchmarks for economic performance. Real GDP measures economic productivity adjusted for inflation, which measures growth that is not due to goods getting more expensive. GDP is published by the Bureau of Economic Analysis.
University of Michigan Consumer Sentiment Index
The index is derived from surveys of 500 households by the University of Michigan on consumer finances and attitudes regarding the economy. The index is set to 100 as of 1966, reached a high of 107.3 in June of 1999 and a low of 56.4 in June of 2008. High consumer confidence levels lead to robust consumer spending, whereas low consumer confidence levels lead consumers to pull back on spending.
S&P 500® Index
The S&P 500® Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.
Chicago Board Options Exchange (CBOE)
Volatility Index® (VIX® Index)
Created by the Chicago Board Options Exchange (CBOE), the Volatility Index®, or VIX®, is a real-time market index that represents the market’s expectations of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500® index options, it provides a measure of market risk and investors’ sentiments.
The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of June 2024. This document is provided for informational purposes by AIM LLC, a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America. These views may change as interest rates, market conditions, tax rulings, and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. This report does not constitute a solicitation or an offer to buy or to sell any security, product, or service. It is not intended and should not be used to provide financial advice as it does not address or account for an individual's circumstances. Consult with your advisor and tax professional before taking any action based upon the information contained in this document. Past performance does not guarantee future results and no forecast should be considered a guarantee. Any investment and economic outlook information contained in this document has been compiled by AIM LLC from various sources, including affiliated entities. AIM LLC takes reasonable steps to provide up-to-date, accurate, and reliable information, and believes the information to be so when provided, but no representation or warranty, express or implied, is made by AIM LLC as to its accuracy, completeness, or correctness.
Products are issued by Allianz Life Insurance Company of North America. Registered index-linked annuities (RILAs) are distributed by its affiliate, Allianz Life Financial Services, LLC, member FINRA, 5701 Golden Hills Drive, Minneapolis, MN 55416-1297. 800.542.5427 www.allianzlife.com
