Inflation and interest rates have likely peaked and a new global economic cycle is on the horizon for 2024, a Guernsey audience has heard from Julius Baer’s Chief Economist, David Kohl.
The impact of high inflation will still be felt next year, but pressures that continue to drive it upwards have lessened and signs show that in many nations it will return to nearer 2%, which is the figure that central banks tend to aspire to, and consumers expect.
Mr Kohl shared data gathered by his team to support their findings and advised on economic performance throughout 2023. He said: “Economies have done remarkably well this year considering the tightening of monetary policy.
“There tends to be a lag of about 12 months until we see the full impact of tighter monetary policy on the economy and inflation figures, so only now can we say with a degree of confidence that June 2022 seems to have been the peak of inflation in many economies.”
Underlying inflation in the United States and the Eurozone was at just above 2% according to the last set of data published by Julius Baer. Falling producer and import prices in the Eurozone, and business markups in the US – all factors that cause inflation – are down significantly from their mid-2022 peaks.
Mr Kohl said that a recession, which was a fear for many economists coming into this year, seems to have been avoided: “The US, the UK and Europe have all more or less avoided recessions and the private sector in many economies have quite healthy balance sheets. Of course some industries – especially interest rate-sensitive ones like construction and real estate – are still struggling slightly, but they didn’t collapse.”
Investment had remained high even throughout the cycle: “The biggest surprise in this economic cycle is that normally, when we see monetary policy tightening we expect investment to drop,” said Mr Kohl. “But this didn’t happen this time. In fact the opposite has happened and investment went up very much in contrast to the post-2008 period, when interest rates were much more favourable for investing.”
Risks from the US and China
Mr Kohl touched on the influential economies of the US and China, with the former showing strong indicators of growth driven by consumer spending.
“We’ve seen US household income going up at the same time as inflation comes down, which is a recipe for increased purchasing power,” he explained. “This is a good sign and consumers are certainly relieved. Whether it’s enough to trigger a boom in consumer spending remains to be seen, but we are hopeful.”
A risk, however, is presented by the ideological polarisation of the Democrat and Republican parties, which is wider than it has ever been. Disagreements make it harder to have a unified stance on the economy, and make a consistent and proactive approach less likely.
Another threat to the global economy comes from a collapsing real estate market in China, with much hinging on how the Chinese Government responds.
The debt of private households in China is higher than in the US, Germany or France, and the private debt service ratio has been steadily climbing and is now above 20%. This is the ratio of the private sector debt service payments (repayment plus interest) compared to its income.
This development is aggravated by falling house prices, which have been in decline for 26 months.
“This is not a blip,” said Mr Kohl. “It’s a long period of property deflation that is making lenders extremely nervous and resulting in homeowners reducing their spending and increasing their saving. So far, the government has not intervened, and it seems they are hoping that economic growth will help households grow out of debt. We’re keeping a keen eye on what happens here as it could affect the overall performance of the Chinese economy, which has an impact on the world stage.”
Cash has been attractive, but won’t win in the long term
Craig Allen, Head of Investment Management at Julius Baer Guernsey, also addressed the audience, reporting on investment portfolio performance.
The main question being asked by Julius Baer clients, according to Mr Allen, is ‘why should I invest when bank deposits alone can earn over 5% return?’.
Cash in the bank has performed well over the past two years due to the poor performance of bonds, which were previously a reliable source of yield for most portfolios. However, when plotted over the last year, cash does not beat balanced portfolios.
“It’s true that the performance of bonds has really hurt investors,” said Mr Allen. “We can see why cash would be attractive, but our data shows that even in a period of good performance for cash, it takes on average two years for a portfolio to catch up – so you’re still far better off in a diversified portfolio in the long run.
“The poor performance of bonds does mean that perhaps we’re looking at a two-and-a-half-year time period before portfolio returns outstrip cash again, so if you’re making a big purchase in the next six months, you may well be better off keeping the necessary resources in cash rather than investing.
“But historical performance data shows that cash in the long run doesn’t work.”
Mr Kohl and Mr Allen were addressing an invited audience at Julius Baer’s Guernsey Market Outlook event at the OGH Hotel on Wednesday 22 November 2023.
Pictured: Craig Allen, David Kohl and Jean-Luc Le Tocq