Inflation vs. Economic Growth: Markets Reassess Their Expectations

The global economy is approaching the end of the year amid conflicting trends. Major economies remain resilient, consumer demand in the United States remains strong, and investments in technology and artificial intelligence continue to support corporate earnings. However, inflation is slowing more gradually than expected, while high borrowing costs are limiting growth prospects.

The main development in recent weeks has been a shift in expectations regarding Federal Reserve policy. Whereas investors previously anticipated gradual interest rate cuts, they are now considering a longer period of restrictive monetary policy and even the possibility of further rate hikes.

High interest rates support the US dollar and bond yields, but at the same time increase the cost of capital and reduce the attractiveness of stocks trading at elevated valuation multiples.

United States: Inflation Leaves the Fed Little Room to Relax

The US economy remains relatively resilient, but the latest inflation data have raised doubts about an imminent easing of monetary policy.

The October Consumer Price Index (CPI), released on November 10, increased by 0.4% month over month, compared with expectations of 0.3%. Core inflation rose by 0.3%, also exceeding forecasts. Inflation in the services sector remains a particular concern.

Markets reacted quickly to the data: yields on two-year US Treasury bonds increased, while the US Dollar Index (DXY) reached 103.08 on November 12, its highest level since the beginning of the year. Investors began assigning greater weight to the possibility of a Fed rate hike in December and further monetary tightening in early 2027.

However, these expectations may prove excessive. Following its December meeting, the Fed could opt for an extended pause. The central bank will need to balance the risk of inflation accelerating again against the threat of an economic slowdown.

Europe and Asia: Different Problems, Different Solutions

The European economy is gradually recovering, although growth remains moderate. Germany's industrial sector continues to face pressure from high costs, weak external demand, and structural competitiveness challenges.

The ECB must balance inflationary risks against insufficient economic activity. Markets expect interest rates to reach 2.75% by the end of 2026 and are also considering the possibility of further monetary tightening in March 2027.

In the United Kingdom, economic activity has improved: GDP grew by 0.5% in the second quarter and 0.7% in the third quarter. Monthly growth in September reached 0.2%. The services sector provided the main contribution, while industrial output remained virtually unchanged and construction continued to contract.

As a result, the recovery remains uneven. Economic resilience allows the Bank of England to maintain a restrictive stance, although further rate increases could put additional pressure on consumers and investment.

China faces the opposite problem: weak domestic consumption, the property crisis, and insufficient private demand are forcing policymakers to maintain economic stimulus measures. However, a sustainable recovery requires not only government spending but also an improvement in consumer confidence.

Japan is gradually moving away from its ultra-loose monetary policy. A weak yen increases import costs and adds to inflationary pressures. Markets continue to anticipate a possible Bank of Japan rate hike before the end of the year. The next policy meeting is scheduled for December 17.

Stock Markets: Technology Optimism Meets Reality

The US stock market remains the leading indicator of global risk appetite. However, November is demonstrating just how vulnerable investor optimism can become in an environment of high capital costs.

As of November 12, the S&P 500 stood at approximately 7,592 points, the Nasdaq Composite at 25,366, and the Dow Jones at 52,297. Over the week, the indices gained approximately 2.9%, 3.2%, and 2%, respectively. At the same time, the technology sector continued to experience elevated volatility.

The situation surrounding companies involved in artificial intelligence is particularly telling. Investors are assessing the massive expenditures required to build data centers, purchase computing accelerators, and develop cloud infrastructure. Demand for computing capacity remains strong, but an important question arises: how quickly will these investments translate into sustainable cash flows?

The market is gradually shifting its focus from technological potential to the economic efficiency of businesses. Even companies with strong competitive advantages can become overvalued if their future earnings are already reflected in their stock prices.

So far, declines among some major technology companies have not triggered a comparable downturn across the broader market. Capital is being partially redirected toward industrials, energy, and consumer sectors. This may indicate a broader market rally, but it also reflects declining confidence in the previous market leaders.

High US Treasury yields make dollar-denominated assets more attractive and may limit capital inflows into emerging markets. In an environment of expensive capital, companies with high valuation multiples and negative free cash flow are particularly vulnerable.