Expectations vs. Reality
Volatility returned to the capital markets in the third quarter, and perhaps the biggest contributor was a change in the expectation of interest rates over the next 12 to 24 months. As economic data came in stronger than expected and inflation remained resilient, the narrative shifted from “soft landing” to “higher for longer.” This change culminated at the Fed’s September meeting, when they sharply revised their economic expectations from back in June, when they had expected to cut rates by one percentage point (four cuts) in 2024, and then another five cuts in 2025. For the remainder of 2023, the Fed has halved those expectations. They continue to project one more rate hike to 5.6%, but now anticipate interest rates will remain at 50 basis points, or half a percentage point higher, in 2024 and 2025 compared to June 2023.
China returned to the world stage in Q3. Since opening up from COVID lockdowns in the first part the year, China was expected to resume as a leader in economic growth. However, those expectations have not yet materialized. Instead, questions have emerged about the country’s debt levels (both corporate and municipal), as well as unemployment and job growth. In August, after youth unemployment numbers had risen sharply, the Chinese government simply stopped publishing them. The data coming out of China has often been suspect, but now it is simply unavailable.
China also appears to have worsening demographic problems, as its total population, especially those of working age, is shrinking. Trade between China and the U.S. has also fallen to the point to where China has become our third largest trading partner, behind Mexico and Canada. Looking forward, China is expected to experience a sizable reduction in its balance sheet as the value of its real estate holdings declines. When mixed with an aging population and rising tensions with the U.S., China may find its growth challenged.
Expectations for Q4 and Beyond
At the close of the quarter, we narrowly avoided a government shutdown. The debate over a possible shutdown had little impact on the markets, however, as the debt ceiling had already been suspended, removing the risk of not paying our debts or issuing Social Security checks. Still, attention did turn once again to our debt level and what impact that might have on economic growth. The debt to GDP ratio is now above 100% and is expected to increase in the years ahead. Many are making comparisons to Europe, which has had the same ratio for some time, along with lower growth. Of course, addressing the debt means tackling entitlement programs, and we still do not seem to have the collective political will necessary to take action. At this time, the most likely path is for the government simply to allow the last round of tax cuts to expire at the end of 2025.
As we think about investment themes that will persist through the rest of this year and beyond, we expect every piece of economic data to be scrutinized and analyzed to give us some indication as to what the Fed will do. And with 2024 being an election year, we also expect the economic agendas of the candidates to be hotly debated. As always, we will have wait and see how closely our expectations meet with reality, but you can rest assured your REDW Wealth team has many ears to the ground, dedicated to protecting your interests and keeping you informed.
© 2023 REDW Wealth LLC. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice. Advisory, Assurance, and Tax is offered through REDW LLC. Wealth Management is offered through REDW Wealth LLC.