Will the soft-landing story play out?

Global bonds returned over 6% in hedged USD terms last year while stocks returned over 20%. 

>> How will the US dollar react to a soft landing in the US?

Global bonds returned over 6% in hedged USD terms last year while stocks returned over 20%. That’s a pretty dramatic improvement on 2022 when global bonds lost more than 11% and stocks were down 18%. It seems likely that much of the recovery stems from a more resilient economic performance than anticipated, falling inflation, and hopes that 2024 will continue to see a relatively soft landing.

“We do think that the soft landing narrative is more likely to hold sway but, we also have to bear in mind what a soft landing might actually mean for longer-term economic performance and hence the ability for financial assets to deliver stellar returns into the future. If we look at one source of the soft-landing story, the labour market, it is clear that the tightness of labour markets, as reflected in high vacancies, for instance, has prevented the sort of sharp rise in the unemployment rate that we’ve often seen in past tightening cycles. But while this is a good thing we also have to remember that trying to force more potential workers to come back into the work force could come at a cost of lower productivity and hence higher wage costs”, said the Standard Bank.

For even though labour participation has recovered from the knock seen during the pandemic, there’s still a sense that enthusiasm for working has been permanently scarred. If we look at the UK, for instance, there is hope that the country can achieve a relatively soft landing. But why does BoE Governor Bailey describe the long-term economic outlook as the worst he has ever seen?

It is because the productive potential of the economy seems so low that the best the UK can achieve in coming years is annual growth that is barely better than zero. And we don’t think that this is just a UK disease. Hence, seen from an equity market perspective, it might be good that low growth and falling inflation will stimulate rate cuts – and so lift equities – but if this easing does little to lift the near-zero growth trajectory going forward it seems hard to describe this as a bullish longer-term outlook for stocks, even if the sugar-rush of rate cuts help lift equities through 2024.

In addition, this has consequences for bonds. For while the sugar rush of rate cuts might aid bond returns in 2024, the longer-term dynamics do not look so good if weak productive potential in the economy lifts budget deficits and gilt supply, and keeps inflation relatively elevated due to high unit labour costs.

>> Did some economies give misleading signals?

A second issue is that asset prices may have been cushioned by the continued aid from central bank quantitative easing; a cushion that will deflate over time, with this process only really getting started in the last year, or so. Allied to this, fiscal questions are still tricky. If we look at the UK again, the government spent much of this year saying that tax cuts were unlikely to be affordable only then to produce the “biggest tax cut in history”, to use the words of PM Sunak in the November autumn statement.

However, this just kicks the fiscal hardship down the line, with tax cuts “paid” for by planned spending reductions in future years which are both deep and goad the opposition Labour Party into maintaining them, or rescinding them. But again, it is not just in the UK where the fiscal chickens will come home to roost. The EU is busy hatching plans to get budget consolidation on track while, in the US some sort of fiscal reckoning seems likely at some point if the country’s dysfunctional political system does not get a grip.

The bottom line is that, even if the soft-landing story plays out, and even if it does seem to be the nirvana through 2024 by producing more gains in both stocks and bonds, as the Standard Bank suspects it will, it is hard to be really optimistic about the long haul.