Pivoting for Good as Macro Worsens

In a webinar hosted by Cyril Regnat, Dirk Schumacher, Théophile Legrand and Emilie Tetard shared their outlook for the coming months.

"Central banks are still key, even though the situation looks more positive"

Cyril Regnat, Head of Research Solutions

Euro Area Growth Expectations

Given the magnitude of the various shocks that Europe has gone through, the fact that recession didn’t happen, is not a bad outcome – but at the same time, growth is nonexistent.

The Euro area contracted slightly during Q3, but are things going to get better? While there is limited data at the moment for Q4, the composite PMI index does not point to an immediate improvement.

When the EU commission asked companies what is holding them back from producing more, where previously it was supply chain problems (or a lack of equipment), today rather, it is a lack of demand that is holding back the Euro area economy.

Likewise, consumption continued to be weak during Q3 too, but as inflation is expected to remain at current levels or decline, there will be a rebound in real income, and we should see a pickup in consumption.

Thus far, the robustness of the labour market has been an important stabilizing factor for the economy, but cracks are starting to show. The strength of employment – one of the previous drivers of income growth – is not there going forward. This (moderate) deterioration of the labour market will in turn contribute to a decline in wage growth – which up until now had been quite strong at 5-6%.

A potential downside risk – which is not the Natixis CIB baseline scenario – is that employment to GDP may decline faster than expected, due to labour hoarding by companies, a phenomenon supported in part by various government employment schemes during the pandemic to prevent high levels of unemployment. What is possible is that if at some point, the corporate sector decides that labour hoarding is not necessary anymore because the medium-term outlook remains weak, the labour market could deteriorate much faster than we anticipate.

“While the market tends to believe that the last mile may be easy and is pricing in rather early rate cuts, we still believe it will take some time.”

Dirk Schumacher , Head of European Macro Research 

Looking to inflation, we saw a big drop in headline inflation in October to 2.9%, which is within touching distance of the 2% target. While the market tends to believe that the last mile may be easy and is pricing in rather early rate cuts, it may not be the case. Our forecast is that even by the end of 2024, we will still be above the ECB’s target. The forces driving inflation down now will begin to fade out and will not be there anymore moving forward, which means it will take some time to reach the 2% level. We believe the ECB will cut rates significantly later than current market expectations – and we remain committed to our call of September 2024.


Interest Rates Update

September was a month where central banks and markets believed rates would remain higher for longer – stronger pricing on the long end of the curve. October, conversely, saw an easing of long-term rates.

Markets are starting to anticipate weaker economic growth and declining inflation. The 10-year bond yield has declined by approximately 25bps since early October, mainly due to expectations of a more dovish Fed and ECB, but also a worsening macro-outlook. This environment, after the hiking cycle, favours longer-duration positions.

Euribor curve data indicates that the market expects to see almost 4 (-25bps) rate cuts next year, starting in the spring. Our view is that the market is a little too aggressive in terms expectations and that the last-mile disinflation process has been underestimated.

“Euribor data indicates that the market expects to see almost 4 25bps rate cuts next year, starting in the spring.”

Théophile Legrand,  European Rate Strategist

A dovish ECB council member indicated that should inflation falls below 3% on a permanent basis before the summer, the ECB may consider a small rate cut. The consensus of governing council remains that the first rate cut will take place in September.

We expect the 10-year bund yield to end the year at level close to 2.65%, with a gradual decline to 2.2.% by the end of 2024 end.

The US economy had continued to deliver upside surprises, even though we have seen a rise in long term rates since August. We believe that the market is still underestimating the magnitude of the FED rate cuts in 2024. Our scenario points to a more aggressive Fed with 125bps overall. So the 2-year swap is expected to reach 4.25% by the end of 2023. With continued disinflation and slowing activity, the 10-year yield will decrease from 4.35% in December 2023, to 3.60% at the end of 2024.

Looking to sovereign issuance, in the euro area we see a decline from the EUR520bn issued (net) in 2023, to ~EUR400bn in 2024. However the ECB’s quantitative tightening on the APP and a potential quantitative tightening on the PEPP could increase the QT adjusted net insurance to slightly below that of this year.


Risky Assets Outlook

November saw a sharp reversal of October performances. While October saw a strong sell off in risky assets, driven by the rise in real rates, November brought relief for these assets, with a rebound of equities, all risky assets, and a drop in risk indicators.

The Natixis CIB risk perception indication dropped recently, from ~50% in October, to -30% in November, entering a “risk on” environment. But, as interest rates risk has decreased, we expect a  growing focus on the growth factor. 

At Natixis CIB, we still have concerns about macro growth and have highlighted this risk for a few months already. Looking at equity fundamentals, it’s a similar story. There is a lot of optimism from market, but it is important not to forget the risks – in our view, current optimism is too strong.

“There is a lot of optimism from market, but it is important not to forget the risks – in our view, current optimism is too strong.”

Emilie Tetard, Cross Asset strategist

The consensus expects stable earnings for S&P 500 equities for 2023. Next year the consensus expectations are very optimistic, with an expected earnings growth of 11% for the S&P 500 (source IBES). The market is focusing on the good momentum on realized equity fundamentals. However, when combined with macro expectations, even if you do not believe in a recession scenario, there will still be a slowdown. It is also unclear whether margins will be able to maintain in the coming months if the disinflation process continues. Equity fundamentals are still very complex to read, which in our view calls for caution going forward.

That said, even if equities will be complex next year, the good news is that we can expect an easing in the equity- government bonds correlation. While we have been used to a negative correlation during the quantitative easing regime, it has not always been the case. This correlation is in positive territory for a few months/years now. When inflation will be less and less of a driver, we can expect easing in the correlation, which will help asset allocation.

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