We expect three cuts to take the policy rate to 3.75% by the end of this year.

As the Reserve Bank of Australia decides on the next interest rate movement, Mahmood Pradhan, Head of Global Macro, Amundi Investment Institute looks at the state of current rate policy in the US.

“Recent inflation numbers in the US are in line with a short pause in the path towards the Fed’s target, yet bond yields have moved sharply higher since the Fed’s big cut. Medium-term inflation expectations – including FOMC member expectations – have moved higher but most of the increase in ten-year yields since the election reflects a rise in real rates,” according to Pradhan.

The Fed expects inflation about 30bp higher at the end of 2025 (at 2.5%), which implicitly incorporates some changes in policy under Trump, especially tariffs and fiscal easing. Market pricing is volatile and sensitive to monthly inflation outcomes.

“We expect three cuts to take the policy rate to 3.75% by the end of this year, as we believe the US economy will slow towards potential growth just below 2%, with higher real rates and tariffs weighing on growth.

“The US labour market is gradually rebalancing and wage growth does not pose a risk to inflation. Labour demand has been weakening, with fewer openings, lower quit rates, and an increase in temporary jobs. Labour cost indicators – hours worked, wages of new hires – are also moderating. And aggregate wage growth of 4 percent supported by productivity growth.

“Higher real bond yields will be a key headwind to growth and asset prices. The fiscal deficit – expected to be 6% of GDP this year – and associated debt issuance is the more likely reason for higher real rates, and higher term premia – the additional compensation investors require both for holding more debt and for higher inflation uncertainty.

“Breakeven inflation rates have moved marginally higher (inflation swaps indicate similarly). But real rates and term premia have moved more, with the latter at 10-year highs. This is more worrying.”

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Mahmood Pradhan

Amundi economist says macroeconomic impact of AI will take longer to move the productivity needle

Global growth has been on a secular decline since around 2000, with a more pronounced decline following the Global Financial Crisis (GFC). Economists typically cite the sizeable and broad-based slowdown in Total Factor Productivity Growth (TFP) which measures how efficiently labour and capital inputs are used to produce output.

Mahmood Pradhan, head of global macro economics at the Amundi Investment Institute, covers the following points in a recently published thematic paper:

• The long-term outlook for global growth is not promising, largely determined by declining working-age populations and weak investment.
• The secular decline in productivity growth, especially in advanced economies is unlikely to improve in the near term.
• Artificial Intelligence is promising, but its macroeconomic impact will take longer to move the productivity needle.
• Investment in AI-related companies will continue at a healthy pace, which should support AI-related equities as an expanding sector.

He notes “Looking back over longer periods, there were strong advances in productivity after WW2 in the advanced economies and in some of the larger emerging market countries in the 1970s to the 90s, partly because they were starting from relatively low levels of per capita incomes. But since around 2000, the slowdown has been broad-based.

“If these trends continue, global growth over the next decade would likely be sub-3%, compared to just under 4% in the two decades before the pandemic. And that’s before we consider some of the more recent adverse developments, such as global economic fragmentation, increasing security concerns and the transition to net zero.

“Such a subdued growth environment would make it even more difficult to deal with high levels of public and private debt in many countries, increasing inequality and would exacerbate strains on already stretched public finances.

“With no near-term macro impacts from AI as yet, the trend of a secular decline in productivity growth of the last two decades will continue to be determined by demographics (declining working-age population) and weak investment. And these will be the main determinants of the relatively subdued growth outlook over the medium term. Investment in AI-related companies will continue at a healthy pace given the longer-term promise of this technology.

“As a result, we believe the near-term investment implications are primarily for AI-related equities, which is an expanding sector.”

Read the paper.

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The labour market is giving mixed signals.

The US economy is showing signs of deceleration, with falling profit margins and a decline in the leading economic index suggesting a potential slowdown in the coming quarters, according to the Amundi Investment Institute.

Mahmood Pradhan, Head of Global Macro Economics, Amundi Investment Institute noted “Rising delinquency rates on credit cards and auto loans signal to us the increased financial stress, especially among younger and lower-income households. This trend combined with restrictive monetary policy and high mortgage rates are contributing to low housing market activity and we expect this trend to also continue in 2024.”

Pradhan noted other signs pointing to a significant slowdown ahead in the US.

“The Conference Board’s Leading Economic Index dropped for the 22nd straight month in January, continuing to point towards a recession. This indicator suggests that weakness may start becoming more visible. Normally we would have expected a recession earlier, but this time around fiscal policy has been unusually active given low unemployment, together with excess household savings.

“Industrial production is stagnating. Though computer and defence production have been strong and rising, overall manufacturing production has been deteriorating, driven by consumer-oriented companies in particular. Regional Fed manufacturing indicators remained on a weak trend and the latest manufacturing ISM posted its 16th straight month below 50, indicating protracted difficulties in manufacturing.

“Declining profit margins (e.g. S&P 500, as per FactSet) will incentivise companies to cut unprofitable investments and unnecessary costs. Also, a weak outlook for profits of small businesses (as reported by the NFIB survey), which account for around 40% of employment in the US, are in recessionary territory. This should prompt likely reductions in non-residential investments, capex and employment.

Real GDP has reaccelerated, while real GDI, which should be driving demand, has been flattish for seven quarters, something that is very unusual, said Pradhan. “The divergence between GDP and GDI suggests an increased reliance on borrowing and running down savings to fund demand, but we think that this situation will have to correct, especially in a higher rate environment.”

“The weakness in January retail sales and a downward revision of November and December readings signal, in our opinion, a potential downshift in consumer spending – some survey data, such as Michigan consumer confidence, are down for the first time in six months. Some of the weakness was likely a payback following the rise in holiday spending. But we believe that real excess savings are being squeezed by ongoing high prices and the increased cost of borrowing, which are not accounted for in the inflation index, and we expect this to translate into further moderation ahead.”

Pradhan noted “The labour market is giving mixed signals. While payrolls posted upside surprises and the unemployment rate remains historically low, we see slowing cyclical employment and falling weekly hours (which are now back to pre-Covid levels) as evidence of slowing labour demand. Indeed, the low participation rate may have extended labour hoarding and companies may delay headcount reduction. But the labour market behaviour of workers is changing: the quit rate has been declining indicating that workers are finding it more difficult to switch jobs and many more workers holding two or more jobs; employment growth has stalled in the households survey; job vacancies and hiring are falling.

“In our view, this suggests a weakening in employment growth ahead and weaker wage growth as well,” he said.

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