2024 Q4 Capital Market Assumptions
Overview
Uncertainty about when the US Federal Reserve (Fed) would begin its rate-cutting cycle – and the pace at which it would likely proceed – kept markets on edge for much of the third quarter of 2024. Driven by recognition that inflation had fallen and that downside risks had increased, the Fed ultimately followed a more aggressive path, initiating its rate-cut cycle with a 50 basis point cut in September and a 25 basis point reduction in November. US GDP rose by 2.8% in Q3, a modest slowdown from the pace seen in early 2024 but consistent with the historical average. As a result, the projection for 10-year US GDP growth was revised to just above 2%, up from 1.86% last quarter. Against this backdrop, the Q4 2024 Capital Market Assumptions include:
- An annualized nominal 10-year return for Global Equities of 6.5%, a decrease from the forecast of 6.9% for the third quarter of 2024. The small forecast decrease is primarily attributable to less favorable valuations following a 6.7% advance in Global Equities in Q3 2024.
- Global sovereign interest rates moved sharply lower in the third quarter of 2024 as expectations for a more aggressive pace of interest rate cuts by the Fed were priced in early in the quarter ahead of the Fed’s September 50 basis point cut. The long-run forecast for hedged Global Aggregate Bonds is 3.9%, a decrease of 0.6% from last quarter’s forecast.
- The forecast return for a balanced portfolio of 60% Global Equities unhedged and 40% Global Aggregate Bonds hedged is 5.8% annually over the next 10 years, a decrease of 0.5% from the Q3 2024 forecast.
Note: Forecasts may not be achieved and are not a guarantee or reliable indicator of future results
Summary
Q3 2024 Developments Informing Our Long-Term (10-Year) Forecasts:
Uncertainty about when the US Federal Reserve (Fed) would begin its rate-cutting cycle – and the pace at which it would likely proceed – kept the fixed income markets on edge for most of Q3. The summer’s monetary policy highlight was Chair Powell’s Jackson Hole speech that noted increasing downside risks to employment and diminished upside risks to inflation, giving the green light “for policy to adjust.” As the September meeting neared, media reports suggested that a 25 basis point cut wasn’t a foregone conclusion. The Fed ultimately followed the more aggressive path, initiating its rate-cut cycle with a 50 basis point cut on September 18th, setting the target range at 4.75%-5.00%. However, Chair Powell emphasized that the Fed wasn’t in a rush and the large cut in September didn’t imply similarly large cuts at the November or December meetings (subsequently confirmed for November).
The Fed’s decision was in part driven by a recognition that inflation has fallen and that downside risks have increased. Nevertheless, a recession does not seem imminent, at least in the US. Robust domestic demand has continued to support the growth in US economic activity. US GDP rose 2.8% quarter over quarter (annualized) in Q3. While that is a modest slowdown from the pace seen in early 2024, it is consistent with the historical average. Overall, financial conditions have been supportive, particularly as banks have loosened credit deployment. Consequently, we increased our 10-year US GDP growth forecast to just above 2%, up from 1.86% last quarter.
Meanwhile, US headline CPI continued its downward trend in Q3, supported by weaker oil prices and base effects. However, core inflation was mixed, and still meaningfully above the Fed’s 2% target. We lowered the 10-year inflation forecasts across the board in our Capital Market Assumptions (CMAs), acknowledging the impact of global central bank rate hikes.
Outside the US, 2024 GDP growth remains anemic in the Eurozone, although the pace has increased from 2023. Falling inflation provided the European Central Bank (ECB) cover to start its rate-cut cycle earlier than the Fed. But core inflation remaining above the ECB’s 2% target justified a more conservative path of cuts. Following an initial 25 basis point cut in June, the ECB waited until September for the next rate decrease. At the September press conference, President Lagarde indicated that more rate cuts are anticipated, but emphasized they would remain data dependent.
In Japan, the economy is still feeling the aftershocks of the unwinding of the yen carry trade. The Bank of Japan (BoJ) hiked interest rates to 0.25% in late July. The BoJ’s hawkish stance sent the yen higher, forcing carry traders to cover their positions, which triggered a brief global market sell-off in early August. On the political front, former Defense Minister Shigeru Ishiba replaced Fumio Kishida as Prime Minister following Liberal Democratic Party (LDP) scandals.
After a string of disappointing economic activity reports and the failure of gradual measures in stemming the decline of the real estate sector, the Chinese government announced significant policy easing on September 24th to address weakening economic activity and the struggling real estate sector. These measures include interest rate cuts, reserve requirements ratio reduction, and support for the real estate, mortgage, and equity markets. The government followed up with additional measures in early Q4.
Long-Term Global Economic Outlook: We expect real economic growth in developed economies to continue to moderate over the next decade, as it has for the last 30 years. This is due to the limited growth of the developed labor force, which is constrained by domestic demographics. An assumption of no significant offset from improved productivity growth is an additional constraint on growth. Inflation in Developed Markets is also anticipated to moderate over the next 10 years, relative to the elevated rates of inflation observed in 2021 and 2022. Nevertheless, inflation is expected to be somewhat higher than in the period following the Global Financial Crisis of 2008 and prior to the COVID-induced recession of 2020. We expect long-run real economic growth and inflation in Emerging Markets to advance at higher annualized rates than in Developed Markets. Younger populations and higher rates of return on capital in Emerging Markets are driving higher rates of nominal economic output compared to Developed Markets.
Source: PGIM Quantitative Solutions as of 30-Sep-2024. Forecasts may not be achieved and are not a guarantee or reliable indicator of future results.
Equities: Our 10-year annualized nominal forecast return for Global Equities is 6.5%, a decrease from our forecast of 6.9% for the third quarter of 2024. The small forecast decrease is primarily attributable to less favorable valuations following a 6.7% advance in Global Equities in the third quarter of 2024. Our long-term return forecast for US Equities is somewhat lower, at 5.8%. Looking at the rest of the world, Developed Market Equities outside the US are forecast to return 7.7% and Emerging Market Equities are forecast to return 8.3% over the next 10 years. Cheaper valuations, as measured by historical valuation ratios, are driving stronger expected returns for non-US Developed Market Equities versus US Equities. While faster expected economic growth is a positive for Emerging Market Equities versus non-US Developed Market Equities, this effect is partially offset by relatively less attractive income returns.
Fixed Income: Global sovereign interest rates moved sharply lower in the third quarter of 2024 as expectations for a more aggressive pace of interest rate cuts by the Fed were priced in early in the quarter ahead of an initial 50 basis point cut in the Federal Funds rate on September 18th. Our long-run forecast for hedged Global Aggregate Bonds is 3.9%, a decrease of 0.6% from our forecast from the prior quarter, due to the aforementioned decrease in underlying sovereign rates. Our long-run forecast for US Aggregate Bonds is 4.1%, a slightly higher expected return relative to our forecast for Global Aggregate Bonds, attributable to higher initial yields partially offset by a positive contribution from hedging foreign currency exposure. At the end of our 10-year forecast horizon, we expect the Fed’s policy rate to be approximately 3.3%, which is about 180 basis points lower than the midpoint of the policy rate target range at the end of Q3 2024. Outside the US, Developed Market central banks (aside from Japan) are forecast to gradually decrease policy rates as inflation pressures subside and growth remains sluggish. In US credit markets, our forecast for average spreads over the next 10 years is somewhat higher than the spreads prevailing at the end of the third quarter of 2024, informing expected returns of 4.3% for both US Investment Grade (IG) and High Yield Bonds.
Real Assets: Real Assets are broadly defined to include asset classes that have physical properties or have returns that are highly correlated with inflation. We include Commodities, REITs, and TIPS as Real Assets in our CMAs. Our forecasts for these asset classes are expected to outperform our 10-year US inflation forecast of 2.4%.
Private Assets: Our forecasts for US Buyout Private Equity, US Venture Capital Private Equity, US Mezzanine Private Debt, and Global Private Infrastructure are linked to the forecast outcomes of public market assets with a premium consistent with historical empirical outcomes, acknowledging the underlying illiquidity and potential leverage employed in these asset classes relative to public market counterparts. Our forecasts for Core and Opportunistic US Private Real Estate are based on inputs from the NCREIF Property Indexes and linkages to forecast US economic growth and inflation.
Currency and Currency Hedging Returns: Over the next 10 years, we are forecasting generally negative returns for the US dollar relative to Developed Market peers, with outcomes ranging from an annualized loss of -0.4% for the Australian dollar to a gain of 1.2% for the Swiss franc. Forecast outcomes for Emerging Market currencies range from an expected loss of -2.4% for the South African rand to a gain of 0.7% for the Taiwan dollar. Long-term currency hedging returns against a market-weighted basket of Developed Market exposures are forecast to be net positive for US investors as short-term interest rates are anticipated to be higher over the long term in the US relative to the Eurozone and Japan.
60/40 Portfolio Return1: Based on our long-term forecasts, a balanced portfolio of 60% Global Equities unhedged and 40% Global Aggregate Bonds hedged is forecast to return 5.8% annually over the next 10 years, a decrease of 0.5% from our forecast for the third quarter of 2024.
1For illustrative purposes only. All model portfolios have significant inherent shortcomings and do not consider many real-world frictions. There is no current PGIM Quantitative Solutions client portfolio with this composition of assets. It does not constitute investment advice and should not be used as the basis for any investment decision.
