Charlie Jamieson, Chief Investment Officer

"Follow the leader" has generated solid performance for many asset markets tailing the progress of the US economy. As we round out the first quarter of 2024, the US continues to defy predictions of an economic slowdown.

We have previously written about “US exceptionalism”, a term describing the relative outperformance of the US economy, which continues to pull away from many other Western economies. In the absence of material market events so far in 2024, many markets are following moves in US assets while they await significant new domestic catalysts.

This contrasts with the Covid period and subsequent reopening of economies, where events were frequent and market reactions severe.

Given their low domestic growth and better-behaved inflation outcomes, we believe the time is approaching for many Western economies to embark on interest rate cutting cycles – with or without the US Federal Reserve. To this end, we think the most interesting economy to watch may be our neighbour New Zealand, which has led the Australian economy over the past few years, providing a potential glimpse into our own future.

Many market watchers have anticipated global central banks to wait for the Fed to lead the interest rate cycle, expecting a non-stimulatory rate-cutting cycle this year to match the victories in taming realised inflation.

This would see the Fed funds rate move lower, from 5.375 per cent towards 4.5 per cent, but above the US inflation rate of 3.2 per cent, meaning interest rates would remain in restrictive territory.

Other Western economies are cautious to move without the Fed, as lower domestic interest rates compared to the US may weaken their currencies, generating tradeables inflation just as economies are feeling comfortable about having defeated the majority of the inflation shock.

Stronger US economic data is seeing some market participants suggest that the Fed may not need to cut rates this year as real GDP is running above 2.5 per cent, handing the leadership of the rate-cutting cycle to other Western central bankers.

Updated economic forecasts for current GDP in major economies is anaemic at best, with Japan at 0.65 per cent, Canada and the eurozone around 0.5 per cent, and the UK around 0.25 per cent. Meanwhile Germany is expected to remain in recession.

So, while leadership could easily be transferred to the European Central Bank, the Bank of England or Canada, it could be New Zealand that takes the honours of first significant mover among the global crowd.

This is interesting for the expected path of Australian interest rates, as the New Zealand economy tends to lead Australia by a few quarters.

The Reserve Bank of New Zealand commenced its rate-hiking cycle six months ahead of the Reserve Bank of Australia, also reaching its cash rate peak of 5.5 per cent six months ahead of the RBA’s peak.

Over that rate hiking cycle, the New Zealand economy has spluttered to a halt, with negative growth recorded in five of the last eight quarters, along with three of the last four quarters experiencing negative GDP outcomes, with the rate of economic deceleration increasing.

Given New Zealand is also experiencing significant population growth, which should grow the size of the total economy, these numbers are proof that highly restrictive monetary policy settings are crimping economic activity.

Despite the recent improvement in the Australian employment data (a highly volatile data print), other tier-one domestic data has continued to weaken as the Australian economy continues to struggle under higher interest rates and increased cost-of-living pressures.

While many sectors are still enjoying solid volume, spend per client has been falling as the substitution of goods and services runs rife as Australians look to make their pay packets stretch further.

Given New Zealand’s six-month lead in the hiking cycle and associated economic weakness, we expect our own economy will continue to lose momentum over the balance of the year, bringing the RBA to the rate cutting table in the second half of 2024.

While recent market sentiment has softened around the timing of Fed rate cuts, the Federal Reserve governors have held their ground, suggesting via their last meeting’s dot plot series updates (a forward estimation of their expected interest rate pathway) that they continue to expect three rate cuts over 2024.

Fed chair Jerome Powell has reiterated this message in his own communications, and it has been our expectation that this process would be front-loaded from mid-year to remain apolitical ahead of the US presidential elections in November.

While the US economy has been truly exceptional, it may well continue to lead the cycle if the Fed sticks to its own script. Either way, global rate cuts will be with us shortly, providing much needed relief for markets and mortgage holders the world over.

Conversely, for savers who have enjoyed much higher interest rates over the past few years, this is bad news as savings rates and term deposit returns decline in line with cash rates.