Mid-Year Outlook: 10 Questions for the Rest of the Year

In our latest investors' survey, our clients were primarily concerned about two main risks for 2024. Firstly, the geopolitical climate, which is seen as the major risk for the months to come. Indeed, almost half the world will be headed to the polls - particularly in the United States and Europe, and now in France, which is generating a great deal of macroeconomic and market uncertainty. Secondly, the risk of persistent inflation, which would force central banks to stick to a restrictive monetary policy. Other potential challenges, notably that of a property or tech stock crash, are also a cause for concern, albeit to a lesser extent.

What is the situation at this stage? The overall macroeconomic scenario is fairly reassuring, with global growth holding steady, inflation stabilizing at around 2-3%, and interest rate cuts in the cards. The United States is set to exceed 2% growth, and China is likely to reach its official target of 5%. Europe, at 0.7%, is approaching its growth potential. Japan is slowing but remains close to its potential. Emerging economies are maintaining sustained growth, India in particular with over 8% growth in the first quarter of the year.

The hyper-inflationary bubble, associated with the risk of a wage-price spiral, is under control. This will restore purchasing power, and consumer spending is looking good. The vast majority of OECD central banks will therefore be able to embark on a cycle of rate cuts, already initiated by Switzerland, the Nordic banks, and the ECB, which will also provide a boost to certain sectors such as real estate. One notable exception is the Bank of Japan.

In our view, the ECB should cut rates three more times this year – in September, October and December, and the Fed may initiate a 25bp cut in September and continue with a 25bp cut in December. This is the real pivot we were expecting for 2024, even if it comes a little later than anticipated.

Our experts at Natixis CIB Research have examined the 10 main questions to focus on for the rest of the year. Watch the replay as they deliver their forecasts and read more in our special report.

The European economy has shown good resilience so far: at +0.3%, growth is stronger than expected. Household consumption rebounded at the start of the year, disinflation is well underway, the labour market has remained solid, and business investment should pick up with lower interest rates in sight.

However, political risk has clearly increased in Europe. Admittedly, the European Parliament will have a governing majority and the European Commission will be all about continuity, with an agenda focused on competitiveness.

Early elections in France imply increased uncertainty, in particular with respect to fiscal policy. The outcome could lead either to a deadlocked Parliament and a minority government (our baseline scenario), or the adoption of unfunded policies that would be very much at a tangent to the European agenda.

To date, France has shown resilience, with growth of 1.1% last year, consumer spending strengthening and foreign trade more positive than in other eurozone countries. We maintain our basic scenario of an OAT/Bund between 60 and 80 bp even after the elections, as it is highly unlikely that a government will emerge with an absolute majority. What could cause the spread to explode would be if France drastically changed its relations with the European Union.

Across the Atlantic, we observe a certain convergence between Europe and the United States. The US economy is showing impressive resilience and should now undergo a soft landing, the big uncertainty coming from the US elections.

Consumption is underpinned by the baby boomers, who hold half of the net wealth of households, which rules out the possibility of a contraction in the economy. But there is a growing divergence between these high-income households and low- and moderate-income households. Activity among 1/3 of the population has slowed. The lowest income segments have begun to feel the consequences of the monetary tightening policy, with defaults on car loans and credit cards. Savings accumulated during the pandemic have melted away, and consumption is increasingly driven by borrowing.

The labor market should normalize, and wage growth should remain moderate at around 3.5%. So there is little risk of wages overheating. Inflationary pressure is easing. All these factors combined support our assumption that Fed will cut its key rates twice this year.

In compare the political priorities of Donald Trump and Joe Biden, we bear in mind that they both already have a track record as president. Joe Biden has prioritized industrial policy and decarbonisation in his first term, and his spending program for 2025 focuses on social initiatives, particularly in education and healthcare, financed by tax rises on corporations and the richest households.

In turn, immigration and trade policy will remain Trump's priorities if he wins the election. He has promised to stop the flow of immigrants and deport illegal immigrants, and to intensify the tariff policies. This could weigh on the job market, creating shortages in certain sectors of activity, and the taxation of imported products would weigh on the purchasing power of the most modest households.

But whatever the outcome of the election, the winning candidate will have to deal with Congress. Republicans currently hold a very small majority in the House of Representatives, whose fate is undecided. We believe the Senate, currently controlled by the Democrats, will pass into Republican hands in 2025, which would make harder for Joe Biden to implement his program.

China's growth is expected to remain close to 5%, which although still buoyant, is slowing. Indeed, growth in domestic consumption is very weak, and the main driver of Chinese growth is exports, particularly to Europe. Against a backdrop of trade wars, which could intensify should Donald Trump win the election, China's export engine slows down.  In addition, investment, which has been the driving force since 2008, is only growing by 4%.

The property situation is no longer the main risk for the Chinese economy. The sector remains small for banks and households can meet their loan installments. In our view, the primary risk to the Chinese economy is the growing local government debt and the associated costs. China will likely have to make the bold decision to centralize local debt.

While the Federal Reserve has shifted to a rather neutral stance as inflation turned out to be stickier than expected, the ECB initiated its policy rate cuts at its June meeting. The ECB will base its next steps on European data. If it turns out that inflation is at its target level, it will continue to cut rates. We expect three cuts, in September, October and December.

If it turns out that the Fed keeps rates unchanged, which is not our expectation, this could limit the ECB's scope for action because of the EUR/$ exchange rate, which would limit the inflation outlook. In the US, the disinflation process that was interrupted in the Q1 resumed in April. The labor market continues to normalize and we see no additional pressure in terms of wages. The Fed is therefore likely to cut rates twice this year by 25 bp, in September and December.

In the space of a few months, the market has gone from one extreme to the other. From 150bp, market consensus has lowered Fed rate cut expectations to just 30-35bp (for our part, we expect 50 bp). Similarly, expectations of a steepening yield curve have been shaken, with the sharp rise in short rates preventing slopes from rebounding.

The low expectation of key rate cuts, the maintenance or even strengthening of term premiums, investors' appetite for long maturities and the market positioning, which is relatively neutral for the time being, all constitute supportive factors to steepening positions.

The re-steepening will be more progressive than initially thought, and we see more potential in Europe than in the USA due to our ECB scenario. We consider segments 2Y-10Y slopes to be the most attractive one at the moment.

Defiance towards the dollar has increased among the Global South, which, more and more, is seeking to reduce its exposure to the USD, with initiatives such as bilateral trade agreements in local currencies, or the introduction of alternative payment systems to SWIFT, such as those set up by Russia following the invasion of Ukraine, China and India, which last year processed the equivalent of half its GDP.

China has been trying to globalize the yuan since 2010. One of its vehicles for doing this is  lending to emerging countries in its own currency. Or in denominating its trade in yuan, which accounts for half of its foreign trade. But these efforts remain marginal: the Chinese currency accounts for barely 2% of the world's foreign exchange reserves.

The US dollar remains the dominant international currency. It still accounts for 59% of foreign exchange reserves, 90% of transactions and 65% of the world's debt is denominated in dollars, underpinned by a robust economy, relative political stability, a powerful army, innovation and the liquidity of US assets. It is expected to weaken next year due to cyclical forces, but this will be conjectural.

Fundamental trends, such as the transition to locally-produced renewable energy and the reshoring of industrial production should, in the long term, reduce world trade and hence, the importance of the dollar. Alongside the digitalisation of economies and the gradual arrival of digital central bank currencies. But these are very long-term trends.

Underlying trends such as energy transition, production reshoring, military tensions and associated spending, aging population leading to a rise in healthcare spending, spending linked to the digitalization of economies – are driving massive investment, partly financed by recourse to public debt… Debt levels have soared in recent years. The US debt trajectory, estimated by the CBO at 250% of GDP by 2050, is deemed "unsustainable". France is the focus of much attention, with expensive budget programs in the pipe.

In an environment of higher interest rates and lower private savings, this raises the question of the sustainability of public debt, and whether there is a sustainable level of real interest rates.

It turns out that when we simulate shocks to public debt over the medium term, we find that it remains manageable. Sustainability actually depends on the combination of the amount of debt, interest rates and growth. To be sustainable, these three criteria must not deteriorate concurrently.

On the bond markets, the risk of a deterioration remains the focus of investors' attention over the coming months, particularly for France and Italy. The OAT/Bund spread remains the most vulnerable because of the political situation in France. It is likely to be around 60-80 bp, with high volatility.

Against this backdrop of heightened geopolitical risk, which asset allocation should be favored? With high volatility and the current yield curve, it is complicated to take duration risk. Our experts recommend carrying shorter durations and to invest in equities, which should continue to perform as long as macroeconomic data and corporate results hold up. Investors wishing to diversify their allocations may wish to consider more dynamic strategies, such as long-short.

US equities could also be a good alternative. But investors must have in mind the predominance of tech in the main indices - 7 stocks account for 43% of the Nasdaq index - and their very high valuations. In this regard, are we on the verge of a tech stock crash? If investors’ appetite - particularly for assets linked to artificial intelligence - continues to support tech stocks, we think they will be paying closer attention to AI monetisation strategies in the second half of the year.

After a buoyant H1 for credit, sensitivity to political risk has resurfaced. The European elections and the prospect of French elections have led to a fairly rapid widening of spreads, impacting high-beta and financials in particular. We believe that the risk/return trade-off is better on the low-beta parts of credit, i.e. corporate investment grade. We believe that there is a risk premium to be seized on Real-Estate, whose values have, in our view, reached a low point, as well as on the automotive and aerospace-defence sectors.

Due to rather mild winters and the accelerating electrification of economies following the energy crisis, gas prices are starting to fall. As for oil, it has not been sensitive to the risk of loss of supply linked to geopolitical tensions, due to OPEC's available excess capacity and the weight of the United States in world production. The price of a barrel of oil should be around $80 in 2025.

As for metals linked to the transition, gold reached record levels in the first half of the year. Prices are now set by China, the world's biggest consumer, producer and importer of gold. It has overcompensated for Western gold sales linked to high real interest rates. Interest rate cuts by central banks should be favorable to gold, with the ounce expected to average $1,500 by 2025.

Lithium, essential for battery production, is in abundant supply, limiting the risk of shortages and soaring prices. Copper, on the other hand, which is essential for electricity transmission, is experiencing a structural production shortfall due to under-investment in the sector.