The big picture
And they’re off! But how far will rate cuts go, and with what impact?
Most of the world’s central banks have begun cutting interest rates as the big inflationary shocks from the disruptive consequences of Covid-19 and Russia’s invasion of Ukraine finally begin to fade. The US Federal Reserve (Fed) became the latest to ease policy in September.
Past hikes in interest rates have restrained economic growth and, with it, consumer price inflation and wages. This, along with signs of normalising supply chains and labour markets, has given central banks confidence to cut interest rates in a fairly synchronised fashion.
But policymakers at the Fed and elsewhere are rightly cautious given inflation remains above target in many places. Core inflation, especially, is still uncomfortably high thanks in large measure to ongoing price rises in services. Central banks are keen to stress the pace and magnitude of further monetary easing will very much depend on economic data.
This caution is warranted. If the decline in inflation accelerates interest rates are likely to fall further. Then again, deflation and a return to zero or even negative interest rates looks unlikely. And if economic growth picks up after modest rate cuts, banks are likely to pause and may even reverse course. Both outcomes are possible looking ahead to next year and beyond.
We see global economic growth roughly stable, at 3.1 per cent this year from 3.3 per cent in 2023, and a similar rate of increase of 3 per cent in 2025. Real interest rates remain positive and should continue to impart some restraint on investment and household consumption and impact the housing sector.
While the world economy as a whole looks to be heading for a “soft landing”, the picture is far from uniform. The US and India are performing comparatively well, whereas the EU and China are facing growing problems. In Europe, rate cuts and reduced austerity could deliver an upside surprise, while China’s recent stimulus can also help restore confidence and demand, if the fiscal and monetary easing gains traction, cushioning the slowdown there and also boosting some other economies.
The US economy is likely to grow 2.6 per cent this year, similar to last year, while India is forecast to grow nearly seven per cent. Forecasts for both have been steadily revised upward through the year. The outcome of the US presidential and congressional election could have a big bearing on how the world economy fares in 2025 and beyond given its potential impact on US fiscal policy, trade policy and regulation.
The Eurozone and China, by contrast, are facing a more challenging growth outlook in industry and housing, respectively. We expect growth in the euro area to reach one per cent this year, and be not much better in 2025, dragged down by ongoing weakness in Germany. China is in the midst of a structural slowdown and after straining to reach five per cent growth this year, the government may have to settle for closer to 4.5 per cent in 2025 even with the recently unveiled measures in late September.
The UK has found political stability but the shape of the new government’s fiscal and regulatory policies remains uncertain. Inflation is proving sticky and while the economy has been performing better than anticipated, the risks seem skewed to the downside. Eventually, we expect this will spur the BoE into more forceful easing.
Japan’s underlying growth rate is a little over one per cent and 2025 should see ongoing steady progress. That should enable the BoJ to swim against the current and raise interest rates somewhat further.
As for emerging-market economies, the prospect of a soft landing provides a relief as it should mean commodity prices are close to troughing. With bond yields peaking, interest rates falling and the dollar having weakened the macro environment is more supportive for now. However, rising protectionism is a concern and could be ratcheted up were Donald Trump to be re-elected and follow through on some of his more extreme threats.
Figure 1: Aviva Investors’ growth projections
Source: Aviva Investors and Macrobond as at September 30, 2024.
What this means for asset allocation
Equities
Equities remain attractive, given the prospects for sustained economic growth, further interest rate cuts and with credit spreads and lending conditions stable. Corporate profit growth remains robust, with a high degree of visibility on future earnings, and profit margins remain resilient. Indeed, the profit cycle troughed much earlier than the usual historical pattern, which usually is long after rates have peaked and begun to decline.
Structural drivers such as high levels of investment in artificial intelligence along with rising expenditure on biotechnology, the energy transition and electrification, and defences, should continue to lend support.
However, the pace of gains is likely to moderate and volatility could pick up, given the stellar performance already delivered. We have reduced our overweight exposure and favour US stocks given the relative strength of the US economy, and Europe where valuations look extremely cheap notwithstanding the more depressed economic backdrop. By contrast we are underweight emerging-market and Asian equities.
Figure 2: Asset allocation – equities
Note: The weights in the asset allocation table only apply to a model portfolio without mandate constraints. Our House View asset allocation provides a comprehensive and forward-looking framework for discussion among the investment teams.
Source: Aviva Investors as at September 30, 2024.
Government bonds
While yields have fallen, government bonds continue to offer valuable diversification benefits in the event economic growth stalls. Interest rates may have started falling, but it seems they will end the cycle materially higher than prior to Covid. While market expectations for US rate cuts seem sensible, we believe the European Central Bank will end up cutting by a little less than the market expects and the Bank of England by more. In contrast, the BoJ will continue to tighten policy.
We are overweight the US and UK markets and underweight Japan. The US economy has slowed thanks to a weaker labour market. US bonds are not pricing in a recession, contrary to some headlines, but rather a “soft landing”. That suggests the risks to US yields are asymmetric, as interest rates could fall substantially should the slowdown in the labour market begin to accelerate signalling the economy was in danger of falling into recession.
We also like the UK market, favouring shorter maturity bonds given our expectation the Bank of England will be forced into lowering interest rates further and faster than the market anticipates. Longer dated bonds conversely will be held back by concern over the state of the UK government’s financial position.
We are underweight Japan as we believe the Bank of Japan may be forced to tighten policy by more than the market envisages (swaps implying rates only around 0.5% next year), given signs that inflationary pressures continue to build.
Figure 3: Asset allocation – government bonds
Note: The weights in the asset allocation table only apply to a model portfolio without mandate constraints. Our House View asset allocation provides a comprehensive and forward-looking framework for discussion among the investment teams.
Source: Aviva Investors as at September 30, 2024.
Credit
Corporate bonds have performed steadily. While the main fixed income asset classes (European and U.S. IG and HY, as well as EM external sovereigns and corporates) do not look especially cheap relative to safer government bonds, from a historical perspective, there is no reason to expect spreads to widen significantly so long as a recession is avoided.
Given our expectations economies are heading for a soft landing, we prefer riskier high-yield debt to more highly rated investment grade bonds.
Figure 4: Asset allocation – credit
Note: The weights in the asset allocation table only apply to a model portfolio without mandate constraints. Our House View asset allocation provides a comprehensive and forward-looking framework for discussion among the investment teams.
Source: Aviva Investors. Data as of September 30, 2024.
Four key investment themes
1. Synchronised rate cuts
With inflation risks subsiding and labour markets more in balance, the case for lower rates over the coming year appears more compelling. In our central scenario we see central banks delivering something close to what is priced into markets.
However, there is considerable uncertainty around the outlook – with the precise magnitude of easing likely to reflect the extent to which labour markets soften further from here. With central banks moving to cut rates before a material rise in unemployment, we expect a soft-landing can be delivered, which would support risk assets.
Figure 5: Cumulative change in policy rates since September 2021 (squares based on market-implied pricing for end-2025)
Source: Aviva Investors, Bloomberg and Macrobond as at September 30, 2024
2. Soft landing; inflation risks receding
Ever since central banks started raising rates aggressively in 2022, there has been concern that tighter financial conditions could drive the global economy into recession. However, while interest-rate sensitive sectors such as housing did cool significantly, as the months went by in 2023 it became evident that economies could withstand higher rates, with output slowing, but not falling off a cliff. In aggregate, balance sheets remained healthy and fiscal support remained a constant tailwind.
Financial and credit conditions began easing some time ago, supporting activity and asset prices, as markets anticipated rate cuts in official interest rates. Easier monetary conditions should keep financial conditions loose and help deliver a soft landing.
Figure 6: Global nominal GDP estimate
Source: Forecasts are Aviva Investors and Macrobond, as at September 30, 2024
3. US election – too close to call, too important to ignore
The outcome of this November’s US presidential election is too close to call. But it could have a major impact on the economic outlook both in the US and beyond and, with it, financial markets.
Whoever wins power, the deficit is likely to widen from an already historically high level, assuming their party controls Congress. If Trump were to win and chose to impose the kind of tariffs he has threatened, that would be a very significant escalation from his first presidency and would almost certainly result in retaliation from trading partners. As for Harris, if she were to hike corporate tax rates, it would reverse much of the cuts that came in the Trump administration and could be a material headwind for US companies.
Figure 7: Key policy proposals from the two US presidential candidates
| Harris (Democrats) | Trump (Republicans) |
| Policies that increase the deficit: - Extend expiring individual tax cuts for those earning under $400k - Expand child tax credits - Expand earned income tax credit - Enhanced subsidies for health insurance - First homebuyer credit - Remove tax on tips | Policies that increase the deficit: - Full extension of expiring individual tax cuts - Exclude social security from taxation - Cut corporate tax to 15% from 21% - Increase defence and government infrastructure spending - Increase child tax credit - Remove tax on tips |
| Policies that reduce the deficit: - Raise corporation tax to 28% from 21% - Raise capital gains tax for high income earners | Policies that reduce the deficit: - 10% across-the-board tariffs and significantly higher rate on all Chinese imports - Removal of subsidies for EVs |
Source: Aviva Investors as at September 30, 2024.
4. The AI capex boom, and monetising the technology
In previous editions of the House View we have looked at this theme from the perspective of its potential to boost productivity. But the prospects of monetising developments in artificial intelligence (AI), continues to grow in importance for investors.
The biggest technology companies and others have invested substantial amounts. But the return on that investment and clarity on the resulting use cases is still some way off. If the AI hype is to meet the lofty expectations of the market, monetisation and revenue generation – by both the producers of the tech and its adopters – will need to follow.
Figure 8: AI Capex to Sales
Source: Workspace as at September 30, 2024
Read the House View
House View Q4 2024
And they’re off! But how far will rate cuts go, and with what impact?
The Aviva Investors House View Q4 2024
Transcript for video #
Hello, and welcome to the Aviva Investors Q4 2024 House View Webcast. The main things to watch, I think, are geopolitics and trade, some of which we'll know in the third quarter with the election result.
But even that will kind of spill over into 2025. Soft landing means we remain, constructive on equities, but we have, reduced somewhat off of the back of concerns, around the volatility and uncertainties that are out there, and then holding rates, longer term bonds will help diversify portfolios and protect them should some of those uncertainties arise.
Click here to watch the Q4 2024 Aviva Investors House View Webcast.
Transcript for video #
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About the House View
The Aviva Investors House View document is a comprehensive compilation of views and analysis from the major investment teams.
The document is produced quarterly by our investment professionals and is overseen by the Investment Strategy team. We hold a House View Forum biannually at which the main issues and arguments are introduced, discussed and debated. The process by which the House View is constructed is a collaborative one – everyone will be aware of the main themes and key aspects of the outlook. All team members have the right to challenge and all are encouraged to do so. The aim is to ensure that all contributors are fully aware of the thoughts of everyone else and that a broad consensus can be reached across the teams on the main aspects of the report.
The House View document serves two main purposes. First, its preparation provides a comprehensive and forward-looking framework for discussion among the investment teams. Secondly, it allows us to share our thinking and explain the reasons for our economic views and investment decisions to those whom they affect.
Not everyone will agree with all assumptions made and all of the conclusions reached. No-one can predict the future perfectly. But the contents of this report represent the best collective judgement of Aviva Investors on the current and future investment environment.
House View contributors
Michael Grady
Head of Investment Strategy and Chief Economist
David Nowakowski
Senior Strategist, Multi-asset & Macro
Joao Toniato
Head of Global Equity Strategy
Vasileios Gkionakis
Senior Economist and Strategist
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