Bold and decisive actions are essential to uncover opportunity in an uncertain world; waiting for clarity will hand the opportunity to your competition and has never been an effective strategy. "Success is not final, failure is not fatal: It is the courage to continue that counts."1
In Ovid’s Metamorphoses, the inventor Daedalus and his son Icarus are held captive in a high tower by King Minos to prevent them from revealing the secrets of the Knossos labyrinth and the Minotaur imprisoned within. Every day Daedalus ponders their escape, and how they might conceive the inconceivable to break free.
Whilst this paper is not suggesting that the global financial services ecosystem is hiding a Minotaur, bear with the story and the relevance of this ancient Greek myth as an analogy to substantiate actions required in the current climate.
The market entered 2023 anticipating an imminent recession but the markets defied the consensus and recorded growth across all major jurisdictions, notwithstanding growth challenges in the UK which recorded contraction of 0.4% of GDP in Q4 2023. The Eurozone economy grew by 0.5% and the US economy by 2.5% in 2023, above the 10-year trend of 2.3%.
Since the start of this year, the industry mindset has firmly shifted from a focus on tackling the highest levels of inflation since the 1980s and avoiding recession in 2023/2024 – the so-called hard landing – to anticipating imminent rate cuts and a strong belief in the possibility of a goldilocks scenario of avoiding recession and returning inflation to 2% target – in a soft landing.
While central banks navigate the delicate balance of managing inflation and economic growth, all three ‘landing’ scenarios remain on the table with no consensus on which one it will be.
Andrew Bailey, Governor of the Bank of England told the FT after the March Monetary Policy Committee (MPC): “In recent weeks we’ve seen further encouraging signs that inflation is coming down. We’re not yet at the point where we can cut interest rates, but things are moving in the right direction.”2
The March Federal Open Market Committee (FOMC) press release reflected a similar sentiment: “The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance.”3
However, despite the dovish tones in the FOMC meeting, a third scenario has now gained traction; Central banks will not cut rates in 2024.4 In other words, there will not be a landing at all this year. According to a Chicago Booth poll amongst economists, 15% now believe it is likely that the first Fed rate cut will arrive in 2025 or later.5
Similarly, members of the Bank of England MPC, including Jonathan Haskel and Federal Reserve Officials, such as Christopher Waller have all indicated in recent weeks that rate cuts should be “a long way off” and that there is “no rush” to cut rates, supporting the notion of no rate cuts in 2024, and no landing.6, 7
Therefore, while central banks navigate the delicate balance of managing inflation (and the potential disruptive second wave) and economic growth, all three ‘landing’ scenarios (soft landing, hard landing, and no landing) remain on the table with no consensus on which one it will be.
Daedalus famously cautioned Icarus about flying too close to the sun or the sea. Consider, however, a version of the myth of Icarus that speaks not of hubris and (fatal) over-confidence, but instead of finding the right landing path.
Rather than ignoring his father’s advice and perishing, in this revised telling Icarus instead obeys Daedalus and flies mid-way between sea and sun: not too low, where the sea spray might weigh down his wings, nor too high where the sun’s rays might melt them.
The target for central bankers across the US, UK and Europe is to achieve a soft landing in 2024, whereby inflation continues its decline and achieves its target of 2% without pushing the economy into recession.
If we are to experience the anticipated outcome of a soft landing in 2024, we need to achieve a balancing act between inflationary pressures (avoiding the ‘rays’ of high inflation), economic growth and unemployment (avoiding the sea spray of recession).
In this scenario, inflation continues its downward trend, or central bankers accept inflation stickiness between 2% and 3% allowing central banks to start cutting interest rates by the summer of 2024, but do so gradually to avoid reigniting inflationary pressures. At the same time, central banks will continue to reduce their balance sheets at a pace that does not shock the markets, in an attempt at controlled liquidity reduction in the economy and thus avoiding a surge in inflation.
Figure 1: US, UK, and Eurozone Inflation Trajectory (Source: Bureau of Economic Analysis, Bank of England, Eurostat)
Reduced borrowing costs will allow pressures to ease on consumers (e.g. credit cards, mortgage rates, and house prices), business (e.g. debt servicing and re-financing, reduced customer demand, and investment viability) and governments (e.g. borrowing costs and related fiscal policy).
Reverting back to the original telling of the myth, there are a number of reasons why Icarus might fly too close to the sun and melt the beeswax in his wings (sticky inflation or a second wave) or fly too low to the sea such that the waves to take him down (recession).
The dreaded hard landing, whereby the lagged impact of monetary tightening and/or a delayed start of monetary easing causes recession – the much-debated Phillips Curve says that to get inflation down, unemployment must rise.8
The supply chain challenges driven by pandemic-era demand fueled by (excessive) stimulus are passed, and the soaring energy and food prices following Russia’s invasion of Ukraine are moderating. The situation in the Middle East including interference to shipping routes through the Red Sea or increased US-China tension doesn’t change the trajectory of goods prices. For example, the UK CPIH all goods index rose by 1.1% in the 12 months to February 2024, down from 1.8% in January, and the lowest rate since March 2021.9
On the other hand, services inflation, which is domestically generated inflation, remains uncomfortably above target (US: 5.0%, UK: 6.1%, EUR: 4.0%) primarily driven by rapid wage growth, and headline inflation reduction is slowing in 2024 (US: -0.2pp, UK: -0.5pp, EUR: -0.4pp) or even increasing on a 3-month (US & UK: +2.8pp, EUR: +3.9pp) or 6-months (US: +0.5pp, UK +0.7pp) annualized average.10, 11
The dovish turn (or the markets interpretation thereof) that the Federal Reserve, Bank of England (BoE), and the European Central Bank (ECB) took at the end of 2023, as well as the large deficits advanced economies are running, has created significantly easier financial conditions and tailwinds for consumer spending and financial markets and therefore could keep inflation at above target levels for longer.
This will force the hand of central bankers to delay a return to neutral rates whereby there is no restriction nor stimulus to the economy, and it does not come for free. Pressures will continue to build in the financial system, commercial real estate, and regional banks in particular, and increase the risk of rapid deterioration of the economic environment and therefore future rate cuts will prove too little too late.
Jacob Peter Gowy (c 1615-1661), The Fall of Icarus (1635-7), oil on canvas, 195 x 180 cm, Museo del Prado, Madrid
Adopting a forward-thinking approach, focusing on innovation, and seizing the opportunity to make strategic investments early creates a significant competitive advantage.
