Are we heading for the Goldilocks scenario?
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Are we heading for the Goldilocks scenario?

The difficult economic balance of “not too hot, not too cold” needs inflation to fall to target while the economy keeps growing, allowing for rate cuts. Here’s why we think it could happen

Optimism over inflation and interest rates have faded through 2024

While the sentiment shift on interest rate cuts this year appears dramatic, we should bear in mind that the “Goldilocks scenario” represents a difficult economic balance of “not too hot and not too cold”. Inflation needs to fall back to target while the economy keeps growing, allowing for interest rate cuts. Risks can equally come from too much economic growth as well as too little.
The US economy has been leading the way since the Covid-19 lockdown ended, while growth in the UK and Europe was anaemic. But if growth in the US now slows, this should create room for the Federal Reserve (Fed) to cut rates, even as economic recovery in the UK and Europe supports global growth.
At the heart of the current Goldilocks scenario is a virtuous cycle of falling inflation driving both real income gains and moderating wage growth, allowing for interest rate cuts even as the economy grows. We see more flexible labour markets, including in Europe, enabling this process and bypassing the need for a recession.
The US presidential election represents a significant uncertainty with the outcome a coin-toss, as is the contest for both Senate and House. I have previously urged people to read Donald Trump’s 2025 Project website as it is radical and involves significant policy shifts were he to become the next president. If Republicans win control of both House and Senate, barriers to change will be limited. The UK election outcome is less uncertain, as is the outlook, with the desire to be seen as responsible stewards of the economy constraining both Labour and Tories’ desire to be radical.
The Goldilocks combination of continued growth with falling inflation and interest rates is positive for capital markets. Therefore, while we think that government bonds offer the best historical value, we also like equities.
Figure 1: Interest rate cuts expected by end-2024
Source: Columbia Threadneedle Investments and Bloomberg as at 23 May 2024

The first half of Goldilocks – continued economic growth – is in place

The biggest recent improvement is in the UK, which has gone from being the most disappointing economy to, if not the best, then certainly the most surprisingly good. I have been highlighting the UK recovery since the start of the year, and it is now increasingly reflected in market forecasts (Figure 2).
Figure 2: Forecasts for UK growth rise

Consensus forecasts for GDP growth 2024 Q4 on year earlier
Figure 2 Forecasts for UK growth rise
Source: Columbia Threadneedle Investments and Bloomberg as at 21 May 2024. X-axis shows date forecast was made. Estimates and forecasts are provided for illustrative purposes only. They are not a guarantee of future performance and should not be relied upon for any investment decision. Estimates are based on assumptions and subject to change without notice.
The scenario of improving real incomes driving improving confidence to produce much firmer consumer spending is visible in both the UK and Europe. Fears over energy costs had led consumers to continue to increase their savings, which means that the subsequent unlocking will offer a sustained boost to growth.
The US consumer has already spent its “Covid piggy bank” to avert recession in 2021/22. Now, as the US consumer slightly retrenches, we expect soggy consumer spending. That doesn’t mean recession, but there will not be the vigorous vibrancy we have seen of late in the US economy. However, this could be a better balance for the Goldilocks scenario.
PMIs have improved in Japan and China, indicating that both economies should continue to grow. While important structural issues remain, we see positive developments in Japan and believe that the pessimism over China is exaggerated.

Is US inflation too sticky to allow for rate cuts?

Headline US inflation has been below 4% for a year now, as energy prices fell back earlier. However, it has not fallen below 3%, as it has in both the eurozone and the UK, where inflation peaked later but subsequently fell faster.
A major factor is the very high (I would suggest absurd) weighting to rents in the US inflation index. Rental inflation is slow to react to changes, not least because the difficulties of measurement add delays. By contrast, the eurozone inflation index has a much lower weight on rents, allowing a much more rapid decline (Figure 3).
We need sustained low inflation for interest rates to be cut – it is not enough for the year-on-year headline figure to decline just because of base effects. Wage growth is the key to keeping inflation low.
Figure 3: Core inflation is falling fast
Figure 3 Core inflation is falling fast
Source: Columbia Threadneedle Investments and Bloomberg as at 23 May 2024

Wage inflation is critical to other side of the Goldilocks scenario

The key to inflation is wages – both in terms of costs and demand. Here we see a virtuous spiral as falling inflation allows a flexible labour market to moderate wage demands as real incomes recover.
Wage inflation in the US has flattened out, staying above the 4% level, and there is a long wait for the next quarterly Employment Cost Index release. That, together with economic resilience, is why the Fed has backtracked on rate cuts. However, I think that there is a good chance that wage growth resumes its downward trend, with the expansion of the labour force (driven by a surge of unauthorised migration) removing some of the shortages that were causing wage inflation.
The latest figures in the eurozone also disappointed, with wage growth holding above 4%. But we expect the European Central Bank to look through this recent strength because its own research highlighted a new survey of wage growth which shows a declining trend (Figure 4). As a consequence, we expect it to go ahead with its planned interest rate cut in June, leapfrogging to the front of the queue.
Figure 4: Euro area, indicator of negotiated wages % year-on-year
Figure 4 Euro area, indicator oof negotiated wages % year-on-year
Source: Columbia Threadneedle Investments and Bloomberg as at 23 May 2024

Markets

The combination of continued economic growth with falling inflation and interest rates is positive for capital markets. While we think that government bonds offer good value, we also like equities.

Equities appear expensive on most valuation measures. However, expensive equity markets tend to only get more expensive in favourable economic conditions. Any significant valuation correction usually waits until the next recession and I do not see any chance of a recession in the next year.
Current high equity valuations also reflect the “Magnificent 7” of US tech-driven mega-caps. These companies – Alphabet, Amazon, Apple, Microsoft, Meta, Nvidia and Tesla – have overall delivered higher profit margins, even as the rest of the market struggled.
The gold price also decoupled from its inverse relationship with real bond yields since the invasion of Ukraine. This is likely linked to the freezing of Russian assets, including those of 2,000 private individuals and entities prompting a broad shift to alternative safe havens for wealth. I have been drawing attention to this all year and, following sharp gains, gold now appears overbought in the short term.
Overall, we are closer to Goldilocks than seemed likely a year ago with both inflation and recessions risks declining.
5 June 2024
Steven Bell
Steven Bell
Chief Economist, EMEA
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Are we heading for the Goldilocks scenario?

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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