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Macro Scenarios in Focus: Soft-Landing Baseline with Downside Risks

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Macro Scenarios in Focus: Soft-Landing Baseline with Downside Risks

 

Dora Pribeli, Will Baker, and Thomas Verbraken
July 08, 2024

More than half of the economists surveyed in a recent poll indicated that they do not foresee a recession until 2026, suggesting the U.S. economy is still on track for a soft landing.1 However, with the Federal Reserve signaling only one rate cut this year, compared to signaling three in March, rates are bound to remain higher for longer.

Against this backdrop, we updated our macroeconomic scenarios to reflect the latest macro and market data. Under the baseline soft-landing scenario, one-year expected returns for the U.S. equity market are similar to those in the previous quarter and remain at the lower end of their historical range. One-year expected returns for U.S. bonds have slightly increased, further narrowing the gap with equities and placing them at the higher end of the historical range (as shown in the exhibit below).

Downside risks remain

Given the ongoing uncertainty about the timing of rate cuts and economic resilience, our updated alternative scenarios offer different perspectives: Sustained elevated rates might push the U.S. economy into a hard landing; entrenched inflation could lead to a stagflationary scenario; and productivity gains, potentially fueled by artificial intelligence, may spur growth without inflationary pressures. A diversified portfolio of global stocks and U.S. bonds and real estate could gain 3% under a soft landing, but could lose 5% or 10% under the hard-landing and inflation-resurgence scenarios, respectively.2 Additional downside risks to the soft landing include high concentration and crowding in the stock market, and potentially in the longer term, growing U.S. sovereign-debt levels.

Impact to portfolio values under our scenarios

 
Portfolio impact of the scenarios based on market data as of June 27, 2024. Note that the above stress-test results capture the effect of repricing the assets, not the income component. Treasury inflation-protected securities (TIPS) are represented by the iBoxx TIPS Inflation-Linked Index provided by S&P Dow Jones Indices. U.S. Treasurys, equities and corporate bonds are represented by MSCI indexes. Private equity is represented by model portfolios. U.S. real estate is represented by the MSCI/PREA U.S. AFOE Quarterly Property Fund Index. The composite portfolio is 50% global equities (35% public and 15% private), 10% U.S. Treasurys, 10% TIPS, 10% U.S. investment-grade bonds, 10% U.S. high-yield bonds and 10% U.S. real estate. Source: S&P Global Market Intelligence, MSCI

One-year expected returns for major US asset classes under soft-landing scenario



1 Claire Jones, Martha Muir and Eva Xiao, “US Fed will cut interest rates just once this year, say economists,” Financial Times, June 11, 2024

2 The results are generated by using model correlations to propagate shocks to the portfolios, using MSCI's BarraOne®. MSCI clients can access BarraOne®and RiskMetrics® RiskManager® files for these scenarios, as well as the table with shock assumptions.

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