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Allianz Investment Management LLC 2024 4Q Market Outlook 

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 fourth quarter of 2024. 

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Key points:

  • The economy has been cleared for landing, and the Fed’s attempt to deliver a soft landing for the US economy has been buttressed by a 50 basis point rate cut from the get-go.
  • With inflation seemingly in check, a clear switch of focus toward the labor market from the Fed has led to a risk that the market is overpricing rate cut expectations.
  • A recession scare in early August led to a swift decline in equity prices and was a sharp reminder of the concentration risk within the S&P 500 Index and how fickle market positioning was.
  • The shift toward a less-restrictive monetary policy stance from the Fed has supported the recovery of risk-assets and a more broadened outperformance among the components in the S&P 500 Index.
  • The 10-year Treasury yield has moved decidedly below the 4% level, but not much different than where we started the year, even with policy rates being 50 basis points lower.
  • Elections matter, and regardless of the outcome of a seemingly tight political race, deficit reduction doesn’t appear to be in the cards for either political party; fiscal policy in the coming year could have broader implications for interest rates and equity markets alike.
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 2024 4Q Market Outlook: Cleared for landing...

In the words of Chairman Powell, “The time has come” for policy rates to be adjusted lower and instill a less-restrictive monetary policy stance on the U.S. economy. There was a lot of back-and-forth from market participants with regards to policy expectations heading into the September Fed meeting, but the committee ultimately decided to employ a stronger easing bias with a 50 basis point rate cut out of the gate. While the aggressive move was surprising to some (and considering there was one dissenter on the Fed board, Michelle Bowman), the dovish decision from the committee was not entirely inconceivable leading up to the meeting. With goods inflation clearly in deflationary territory and outright inflation appearing to be under control, the runway is open and the Fed has been cleared to attempt the soft landing for the economy. This can only be achieved by slowing the economy just enough to bring down inflation, but not so much as to cause a spiral into recession. Considering that monetary policy acts with a significant lag, opting for an outsized rate cut was likely the right move as concerns over the U.S. labor market have been brought into the equation.

With the rate cutting cycle underway and the balance of risks between the rising inflation and the labor market more equal, Chairman Powell will have some flexibility to dial up or dial down the pace of rate cuts depending on the current set of economic conditions. However, what hasn’t been made clear from the committee is where the neutral policy rate actually is. This is the rate at which monetary policy is neither restrictive nor expansionary, and it is not easily observable. With that in mind, we do see some risk that the market is perhaps pricing a set of rate cut expectations that appears too aggressive. What we learned from the September economic projections from Fed officials is that there is considerable dispersion among members’ views on the path of policy rates. Markets could be setting up for disappointment should the Fed fail to meet rate-cutting expectations in the coming year.

Lastly, with the election a few weeks away, we see ample risk for shifting market expectations as the latest data we have observed continues to show this election as a toss up. The tail-risks are somewhat fatter and there could be some merit to expect the unexpected as U.S. politics have the ability to shape the economy.

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U.S. GDP Growth

In the second quarter of 2024, the U.S. economy experienced an acceleration in growth due to an uptick in personal consumption. Real GDP grew at a seasonally adjusted annual rate of 3.0%, up from 1.4% in the previous quarter. This growth was driven by increased consumer spending, as well as private inventory investment and business investment. However, there are signs of weakness in the U.S. employment picture, as the unemployment rate has steadily increased from 3.5% to 4.3% over the past year, with a corresponding rise in the number of unemployed people. Despite this, the labor force participation rate has also increased. Personal consumption has remained strong, but consumers are spending a higher percentage of their disposable income, suggesting higher borrowing levels. The trade deficit was a drag on growth in the second quarter, as the U.S. economy outperformed global economies, resulting in a stronger dollar and increased imports. Looking ahead, the outlook for 2024 real GDP growth remains at 1.5% to 2.5%.

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Fed funds rate

Following the July FOMC meeting, the focus has shifted from inflation to the labor market and broader economic conditions. Due to a growth scare in August, the market drastically repriced expectations for Fed actions. Currently, nearly 75 basis points of cuts are priced in for the remainder of 2024. The dispersion among the Fed on policy views will likely lead to increased rate volatility, as arguments can be made for both faster or slower rate cuts. Additionally, with Personal Consumption Expenditures (PCE) continuing to slow, real rates are considered very restrictive based on historical standards. Moving forward, Fed policy expectations will likely rely more on volatile labor market data rather than inflation readings. However, three more cuts by the end of the year may be too aggressive without a deterioration in labor conditions. Our forecast is for the policy rate to finish 2024 between 4.75% and 5.25%, but we could see additional cuts depending on the path of the economy.

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Inflation

Core inflation measures have shown improvement since earlier readings this year, indicating a shift in the risk of higher inflation readings. Core PCE on an annualized basis currently stands at 2.7%, which is already within our expected forecasted range for 2024. Deflationary pressure continues to affect core goods, with a year-on-year rate less than one percent, compared to core services which has been well above three percent. While inflation has moderated, we see several risks that could potentially push inflation higher in the U.S., such as escalating trade wars leading to higher prices for imported goods, a sudden halt in immigration increasing costs for services, higher commodity prices driving cost-push inflation, and the continuous rise in shelter costs. Therefore, we continue to see a range of 2.0% to 3.0% for 2024 Core PCE inflation.

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10-year Treasury

With a marginally slowing economy underway and a market bias for aggressive rate cuts, it appears challenging to be tactically overweight duration at this juncture. The Fed continues to be data driven in its decision process and, with risks on the horizon, we see potential for some dislocation on the path of long-term rates. The growth scare witnessed in early August caused a significant shift lower in 10-year rates. As anticipated, 10-year rate levels have drifted higher with recession risks tamed. Moving forward, we expect rate volatility to likely be driven by employment data rather than inflation figures. The U.S. election, geopolitics, and fiscal spending will likely impact 10-year yields over the medium term. With a set of risks that appears more balanced, we forecast a less convicted view that the 10-year yield is within a range of 3.75% to 4.25% by the end of 2024 and continue to see reasons the yield could end above or below that range.

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U.S. Equities

This year’s pleasant surprise of double-digit returns in the S&P 500 is now being augmented by a dovish contribution from the Fed with a 50 basis point rate cut in September. Despite growing earnings and P/E ratios, investors have appeared skittish at times, in particular the volatility witnessed during late July through early August. A mildly negative jobs report was the catalyst for investor angst and drove the S&P 500 down by over 8%. While markets experienced a swift recovery and the unwavering appetite for risk-assets ensued, we continue to observe ongoing uncertainties related to Fed policy, geopolitical tension, and the upcomming election that could drive fat-tail risk events and ultimately impact risk-asset pricing. Similar to our view around long-term rates, we have a less convicted view on equity performance, but we recognize the performance in place year-to-date. To that end, we are upgrading our expectation for the S&P 500 to return in 2024 to an increased range of +5.0% to +15.0%.

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U.S. Election

We are only weeks away from the 2024 Presidential election and polls continue to point toward a tight race. While it remains difficult to predict the outcome in close elections, our analysis takes a step back to understand potential outcomes and the implications to markets as a result. Following Vice President Harris’ replacement of Joe Biden as the Democratic party nominee, we see two potential outcomes for the November elections: a Republican sweep with former President Trump as victor or a divided government with a Vice President Harris as the winner. In either outcome, we emphasize the imortance in the makeup of Congress that will have the most impact on policy changes. With a Republican sweep, we see greater opportunity for a re-acceleration of inflation as Republican nominee Trump has vowed to increase tariffs across the board on trading partners with rates for China increasing to 50%. This could lead to an increase of inflation by approximately 1% to 2.5% and create a drag on GDP by around 0.5% to 1.5%. Personal income tax cuts expire in 2025 and a Republican sweep has a greater chance of renewing those tax cuts, which could prove to be inflationary and ultimately increase the deficit by more than $4 trillion over 10 years. This could be meaningfully impactful to interest rates in an environment where deficits are already stretched, and we would not be surprised to see interest rates 30 to 100 basis points higher should this play out. Other tax provisions that Trump has discussed are lowering the corporate tax rate from 21% to 15%, exempting tips and Social Security benefits from income tax, and perhaps eliminate taxes on overtime hours worked. Lastly, on the topic of immigration, Trump is looking to deport up to 1 million undocumented imigrants per year, which could be negative for sectors in leisure/hospitality, construction, and agriculture. While it’s unlikley all these policies would be enacted in full, watered down versions would certainly be inflationary and deficit burdening, which could lead to a path of higher interest rates.

The other potential outcome we consider is a Harris victory with Democratic control of the House but not the Senate. Since her nomination, Harris has made the race for President a toss-up and therefore significantly reduced the chance of a Republican sweep. Should Harris win, Democrats are likely to ride her coattails to victory in the House. The Senate, however, is a structurally difficult chamber for Democrats to win this cycle as every toss-up Senate seat is currently occupied by a Democratic incumbent. With a divided congress, Harris is likely to only secure tax cuts for households earning less than $400K per year and otherwise preside over a policy agenda that looks like the status quo, which is not expected to result in meaningful moves for the markets. Regardless of which of these two scenarios play out, neither party is focused on deficit reduction. As such, an unsustainable fiscal trajectory could produce rising bond yields and an unsettling backdrop for investors in risk-assets as debt to GDP levels climb to levels approaching 120%.

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List of definitions

Here are the definitions of the key terms used in this market report.

The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of October 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.


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