Global Economy Navigates Shifts in Monetary Policies and Investor Expectations
The third quarter of the year saw significant shifts in monetary policies and investor expectations, shaping the global economy. A disappointing US jobs report in August led to a market correction, causing the VIX to spike to its highest levels since early COVID-19. However, global equities rebounded strongly, reaching new highs in September. Despite the turmoil, labour indicators, retail sales, and earnings reports remained robust, allowing Federal Reserve Chair Powell to adopt a dovish stance.
The US economy slowed, increasing the risk of a mild recession in 2025. Inflation eased in the US and Europe, although Europe struggled with services inflation. Central banks, including the Fed, ECB, SNB, BoC, BoE, and PBoC, cut rates, while Japan maintained its reflationary stance. China faced weak demand and declining profitability.
Equity market valuations remained elevated, with defensive sectors and high-quality fixed-income assets well-positioned to weather potential market corrections. The US economy maintained strong momentum, with real GDP growing by 3.1% in Q2, driven by robust government spending and continued business investment.
Labour Market Resilience
The labour market is normalizing to pre-COVID trends, with payroll gains averaging 202,000 and the unemployment rate rising to 4.2%. Despite this rise, indicators like job openings and the participation rate remain near 2019 levels, signalling a resilient labour market. Inflation is moderating, though services-related inflation, particularly in insurance, remains a challenge.
Market Concentration Risks
Equity markets reflect elevated valuations, with the S&P 500 forward P/E ratio at ~21x, suggesting lower forward returns. Market concentration remained a significant risk in Q3, even though nearly 70% of S&P 500 stocks outperformed the index. Despite this broader outperformance, the market’s heavy reliance on a few large-cap stocks increases vulnerability to potential negative fundamental surprises.
Economic Surprises and Rate Cuts
Recent economic data have shown downside surprises, signalling potential vulnerabilities in the market. The Federal Reserve initiated its easing rate-cut cycle with a 50 bps reduction at the September 18 FOMC meeting, with markets pricing in up to eight cuts through 2025, lowering the Fed funds rate to 2.9%. Uncertainty surrounding the presidential election is contributing to heightened volatility.
European Economy: Mixed Trajectory
Europe’s economic outlook displayed a cautiously optimistic yet mixed trajectory. Major economies such as Germany and France showed resilience, though overall growth remained subdued. Consumer confidence fluctuated, reflecting both improvements and concerns over rising living costs and economic uncertainty.
China’s Economic Challenges
China’s economic landscape faced ongoing challenges. GDP growth decelerated to 4.7% year-over-year in Q2, down from 5.3% in Q1 and falling short of the 5.1% forecast. This slowdown reflects ongoing struggles in the property sector, weak domestic demand, and ongoing trade frictions.
Investment Outlook
Despite potential volatility, the overall outlook for the market remains neutral. The current environment favours active portfolio management across asset classes and supports credit markets, although selective credit risk remains a concern. Bonds: The global shift towards looser monetary policies, excluding Japan, contrasts with commercial banks’ continued tightening of credit conditions, hindering corporate borrowing. While default rates have risen slightly, selective credit opportunities remain. Equities: Equity valuations seem reasonable considering lower interest rates and moderate growth prospects. Limited upside potential exists, particularly for large US equities with high valuations. A blended investment style is advised, as we maintain a positive outlook for US treasuries and short-term high-yield bonds, and a neutral outlook for equities.
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