What Will the Key Market Drivers Be In 2024?

The Big Picture

Welcome to the era of increased economic tensions, rising inflation, heightened sovereign debt, and elevated interest rates—where peace takes a back seat to financial challenges. This is the new normal we find ourselves in.

The momentum toward de-globalization, set in motion immediately after the pandemic, has been confirmed in 2023. Geopolitical tensions ensure that this trend will persist for the foreseeable future. The conclusion of the 'risk-free' world and the disappearance of the 'peace dividend' signify a heightened weaponization of the global economy. Economic policies are now employed defensively, aiming to bolster self-sufficiency in crucial sectors (such as Europe's focus on energy and the relocation of computer microchip manufacturing away from Taiwan). Simultaneously, these policies are used offensively to diminish competitors' economic influence, as seen in China's approach to electric vehicles (EVs).

The surge in protectionism is driven by a significant increase in public debt. In response to this, the US government has taken a proactive stance through the Inflation Reduction Act (IRA), which entails USD 394 billion in tax incentives. This move is a deliberate effort to propel its economy forward, particularly in the green sector. Japan, with its Green Transformation Act amounting to USD 1 trillion, and Canada, with an USD 80 billion plan embedded in the 2023 budget, have both mirrored the IRA's approach. France and Australia have also adopted similar measures.

The ongoing restructuring of the global economy is poised to result in widening disparities between nations, notably in their capacity to transition towards greener energy sources. This transformation may lead to economic inefficiencies and a temporary alleviation of higher prices due to escalating government deficits and debt. However, this very factor may subsequently diminish the preparedness of developed and emerging markets to effectively respond to any future financial or economic shocks.

Main Conflicts in 2023

Source: Council on Foreign Relations (cfr.org)

In 2024, there is a discernible trend indicating that financial assets are poised to progressively incorporate an elevated level of risk within the environment.

My overarching global scenario is built upon three central concepts:

1. A Global Multi-Risk Environment:
   • This encompasses a variety of risks, including climate disasters, economic instability, the inefficacy of multilateral institutions, technological disruptions, supply-chain vulnerabilities, and fluctuating energy prices. This collective risk landscape is anticipated to necessitate a heightened risk premium in financial assets.
2. Sustained Inflation Levels:
   • Contrary to pre-Covid levels, there is an expectation that inflation will persist at higher rates. This sustained inflationary pressure is anticipated to exert continued challenges on economies and monetary policies worldwide.
3. Prolonged Absence of Fiscal Policies for Debt Reduction:
   • Foreseeably, there is a lack of fiscal policies geared towards reducing government debt. This absence implies a continuation of existing debt levels without significant efforts to bring them down soon.

These three key ideas collectively shape the global landscape, indicating the need for a recalibration in financial markets to accommodate the heightened multi-risk environment, sustained inflation, and the prolonged absence of fiscal measures targeting debt reduction.

In summary, my perspective is that financial assets will progressively adapt to the heightened risk environment. This adaptation is influenced not only by the increased risks across various factors but also by the availability of a greater number of investment alternatives offering higher yields.

Inflation: Targets Remain Elusive

United Stated Inflation

Following a surge in December driven by base effects, I anticipate a gradual decrease in headline CPI throughout the first half of 2024, returning to approximately 2.5%. Concurrently, core CPI is expected to exhibit a more stable, albeit gradual, decline towards 2.7% over the same period. Once reaching these levels, achieving further disinflation becomes challenging, and I anticipate it will persist within this range through 2025, remaining above 2%.

Several factors contribute to this outlook:

1. In the Eurozone, the diminishing impact of base effects, which were more pronounced at certain points in 2023, will contribute to a less significant negative influence.
2. Core goods inflation has already shown substantial improvement, and the disinflationary force from this component is likely to diminish.
3. While shelter prices are anticipated to experience further decline, they may plateau slightly above pre-Covid levels. This is attributed to low housing inventories, which have restricted declines in home prices.
4. Core services, excluding shelter, may exhibit more resilience due to the possibility of sustained elevated wage growth. The imbalance in supply and demand in the labour market, despite recent signs of cooling, could contribute to the stickiness of core services inflation.

Eurozone Inflation

Despite the recent moderation in Eurozone inflation, I anticipate a resurgence, driven by the shift from negative to positive base effects, particularly for energy. In 2024, I project Eurozone inflation to hover around the 3% mark. Several factors contribute to my expectation that inflation will not converge towards the 2% target in the coming year:

1. Diminishing Base Effects: The impact of base effects is expected to be less pronounced and negative compared to the conditions witnessed in 2023.
2. Withdrawal of Support Measures: The anticipated withdrawal of certain support measures, such as the reversal of VAT cuts or the gradual conclusion of the French tariff shield, is poised to provide a boost to inflation.
3. Persistent Food Inflation: Food inflation is expected to remain resilient due to factors such as elevated commodity prices, increased labour costs for food manufacturers and retailers, and the looming risks of extreme adverse weather events.
4. Wage Growth Outpacing Inflation: Wages are anticipated to rise more than the inflation rate in 2024. This is attributed to the lagged reaction of wages to inflation, particularly contributing to an uptick in services inflation.

These four factors collectively contribute to my outlook of Eurozone inflation remaining near the 3% threshold in the coming year, diverging from a convergence towards the 2% target.

BoJ: Persistent Commitment to Easing Policies

Amidst the prospect of a potential global economic slowdown and persistent structural deflationary pressures, coupled with the government's unwavering commitment to Abenomics, the Bank of Japan (BoJ) is expected to maintain its current stance in 2024. As the global economy experiences deceleration, the peak in upward pressure on global bond yields is anticipated to alleviate some of the YCC (Yield Curve Control) framework's challenges, providing leeway for the BoJ to sustain its existing policies.

The BoJ appears strategically inclined to lag other major central banks by one cycle when it comes to initiating the normalization process. The prevailing viewpoint suggests that the BoJ may exit from YCC in 2025, foreseeing inflation reaching or exceeding 2% in FY26 and FY27. Following this, a shift away from the negative interest rate policy is projected for 2026, contingent upon confirmation that inflation is consistently at or above 2%, and as corporate savings return to negative territory.

However, if the BoJ cannot anticipate achieving the 2% inflation target in 2025, there might be a revision of the YCC framework. In a scenario where the U.S. economy surpasses expectations and the market ceases to anticipate Fed rate cuts, the BoJ could potentially exit from YCC before the projected timeline of 2025, introducing an element of risk to the forecast.

ECB: Anticipated Delay in Rate Cuts and Full Quantitative Tightening (QT) in 2024

I anticipate that the European Central Bank (ECB) will initiate rate cuts in September 2024. In this scenario, I envision the ECB having inflation projections reaching 2% within the subsequent 18 months, specifically reaching this target in March 2026 by September 2024. This milestone is considered a prerequisite for the ECB to commence its path towards its neutral rate.

Once the initial rate cut is implemented, my expectation is that the ECB will proceed to cut rates by 25 basis points at each meeting until reaching its estimated neutral rate of 2.5% in Q2 2025. While not included in my central scenario, the possibility of another rate hike at the beginning of 2024 is not ruled out. This could occur if inflation exhibits more persistence than anticipated, and economic growth experiences improvement, prompting the ECB to consider further monetary policy tightening.

Regarding quantitative tightening, I anticipate the ECB to persist with its full Quantitative Tightening (QT) on the Asset Purchase Program (APP), which commenced in July 2023. I expect an acceleration of the reduction of its balance sheet by initiating the reduction of holdings in the Pandemic Emergency Purchase Program (PEPP) in Q1 2024, contrary to the current communication indicating QT on the PEPP in 2025 at the earliest.

It's noteworthy that a significant portion of the balance sheet reduction will likely occur through Targeted Longer-Term Refinancing Operations (TLTRO) repayments, with banks expected to repay around EUR 500 billion between December 2023 and December 2024.

Fed: Prolonged Commitment to Higher Rates Implies a Gradual Initiation of Easing Cycle

• While I assert that the Federal Reserve (Fed) has likely reached its terminal rate, having made sufficient progress in the battle against inflation to preclude additional hikes, the current inflation levels are still too elevated for the Fed to contemplate cuts at this juncture.
• My projection anticipates the first Fed cut to materialize in July 2024, with an additional 25 basis points cut in November. This strategy aims primarily to counteract passive tightening that would occur if the nominal policy rate remained steady while inflation decreases. By the end of 2024, I foresee the upper bound settling at 5.00%.
• However, I expect a delayed recession in Q4 2024/Q1 2025, as the impact of monetary tightening on the economy unfolds with a substantial lag. This lag is attributed to the need for refinancing a significant amount of debt that was previously locked into low rates. In response, I anticipate the Fed escalating the pace of easing to 25 basis points per meeting from Q1 2025 through Q3 2025.
• Following this, I envision the Fed halting rate cuts after September 2025, with the upper bound stabilizing at 3.50%. This decision is driven by persistently high inflation settling in the mid-2% range, which hinders further easing efforts.
• The Fed is expected to sustain Quantitative Tightening (QT) at the existing pace of USD 95 billion per month well into 2024. However, there might be a consideration to slow the pace by late 2024 after the initiation of cuts, and the possibility of discontinuing QT altogether by early 2025. This aligns with Fed comments regarding the potential to slow the pace of QT as reserve balances approach 10-11% of GDP.

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