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The New Trade Order between the US and China
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Regionalisation of Supply Chains
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Insights
December 20, 2023
Growth Environment, Disinflation, Rate Hikes
Growth Environment, Disinflation, Rate Hikes – What Are the Implications for 2024?
After a challenging 2022, the year 2023 saw some records, notably all-time highs for the Dow Jones and gold prices. Simultaneously, major central banks rapidly escalated their benchmark rates, reaching 4% in the Eurozone and 5.25% in the United States. This shift in risk attitude in 2023 is attributed to the relatively robust global economic growth and the decline in inflation, one of the central banks' main objectives.
Approaching the year-end, there is growing nervousness in financial markets about the strength of global growth amid high-interest rates. Indeed, market players fear that the rate hikes seen in 2023 may inhibit the economic performance of companies in 2024. According to the World Economic Outlook report by the International Monetary Fund, global growth is expected to slow, falling from 3.5% in 2022 to 3.0% in 2023 and 2.9% in 2024, well below the historical average over the last twenty years (2000-19) of 3.8%. These figures reinforce the expectation of inhibition by the current level of rates. Additionally, growth is uneven across regions, with some emerging economies, such as Argentina and Turkey facing difficulties.
The resilience of the U.S. economy
2023 has witnessed the resilience of the U.S. economy. According to the second estimate released by the Department of Commerce in late November, the United States' Gross Domestic Product (GDP) exceeded expectations, growing by 5.2% on an annual basis in the third quarter of 2023. However, the current level of rates (5.25%) poses a risk to the sustainability of this economic performance. Investors are beginning to fear that the high-interest rate environment may weigh on corporate indebtedness and the real estate market; potentially leading to a slowdown in the country's growth over time.
Eurozone in the Face of Global Economic Conditions
Economic growth in the eurozone remains below that of comparable countries like the United States or other developed countries. This is primarily due to the Eurozone being a collection of more or less economically robust countries that have pooled their monetary tools through a common currency. Added to this, the conflict in Ukraine has undermined one of the economic and political engines of the zone, Germany, whose economy partly relied on access to cheap gas sources to supply their industries, being highly dependent on Russian exports.
The Eurozone has displayed growth around zero for four consecutive quarters. Current projections forecast growth of only 0.6% for the current year, followed by a modest increase to 0.9% in 2024 and a slight improvement to 1.5% in 2025. This underscores the challenge of making a zone with heterogeneous economies governed by a common monetary policy competitive. However, the Eurozone remains home to highly competitive companies and its financial markets remain closely correlated with other global stock exchanges.
Where do we stand in terms of inflation at the end of 2023?
Global inflation slowed sharply during 2023 (what we call disinflation), falling from 9% to 3% in the United States and from nearly 10% to 2.5% in the Eurozone between January and November. This movement was welcomed by financial markets, central bankers, and all economic players because it allowed households and businesses to regain purchasing power in real terms. Positive inflation is a sign of a healthy economy, however, inflation should not fall much lower than the current levels.
What about the direction of inflation in 2024?
Based on its components, inflation is expected to reach its lowest point in the first quarter of 2024 before rebounding due to technical factors and base effects. Furthermore, wage growth rates in the United States and the Eurozone show that they are currently outpacing inflation. Thus, household purchasing power is increasing, which is traditionally a positive contributor to inflation. We can therefore expect inflation to stabilise and then experience a modest increase in 2024.
If inflation stabilises and global growth continues to hover around 2.5% on an annualised basis, 2024 holds out the prospect of a benign economic environment. This will shift market focus to the actions of central banks.
What direction for repo rates?
It is important to recall that the central bankers' mandate is to ensure the economic and financial health of the currency zone they oversee. Thus, if economic conditions remain benign, central bankers will continue implementing their plan to withdraw the liquidity injected into the markets during the 2010s; known as 'Quantitative Tightening' (QT). This programme has several aspects, including a restrictive monetary policy and therefore high interest rates. Recent statements from central bankers (Fed, BoE, ECB, BoA), suggest a commitment to maintaining elevated policy rates longer than the markets anticipate. In this context, some banks, including Goldman Sachs, consider it unlikely that rates will be reduced before the second half of 2024 unless growth disappoints.
Therefore, we anticipate that the current dichotomy, between market players urging central banks to act faster than planned and central banks that stuck to their QT program as long as the economy allows it, will persist. This may lead to sporadic episodes of market volatility, even though we agree that we have reached the end of the rate hike cycle.
Mechanically, Quantitative Tightening should push global yield curves upward but also have an unfavourable impact on the prices of risky assets, including equities during 2024. The first quarter of 2024 will be key and set the tone for the year for several reasons:
- Corporate results for the last quarter of 2023 and the first quarter of 2024 will be closely watched as they will be the first operational results published taking into account the current rate. If the Q4 2023 and Q1 2024 earnings are positive, investors are likely to push back their expectations of rate cuts beyond 2024. Conversely, investors will signal to central banks that they expect swift action.
- Inflation is expected to rebound in 2024, due to technical factors and an increase in purchasing power. This upward correction in inflation could lead to sporadic episodes of volatility between markets anticipating further rate hikes and the fear that these will suffocate companies. However, given the trajectory of energy prices this winter, global inflation should normalise from Q2 2024.
- 2024 will be a political year with national elections in many major countries, including the United States, and the risk of populist or policy lockdown should not be ignored. This could also give rise to sporadic episodes of market volatility.
In conclusion, it appears that 2024 could be a challenging year for directional assets, particularly if the last quarter of 2023 and the first quarter of 2024 earnings season go well. This reinforces our view that yield structured products, with conditional participation (Protected Tracker, KG + Call) or even protection (Warrant Put, Warrant Short) can play a significant role in the performance of a diversified portfolio in 2024.
Please note that this article is for informational purposes only and should not be considered financial advice or an endorsement of any specific investment strategy.
Insights
December 20, 2023
Growth Environment, Disinflation, Rate Hikes
Growth Environment, Disinflation, Rate Hikes – What Are the Implications for 2024?
After a challenging 2022, the year 2023 saw some records, notably all-time highs for the Dow Jones and gold prices. Simultaneously, major central banks rapidly escalated their benchmark rates, reaching 4% in the Eurozone and 5.25% in the United States. This shift in risk attitude in 2023 is attributed to the relatively robust global economic growth and the decline in inflation, one of the central banks' main objectives.
Approaching the year-end, there is growing nervousness in financial markets about the strength of global growth amid high-interest rates. Indeed, market players fear that the rate hikes seen in 2023 may inhibit the economic performance of companies in 2024. According to the World Economic Outlook report by the International Monetary Fund, global growth is expected to slow, falling from 3.5% in 2022 to 3.0% in 2023 and 2.9% in 2024, well below the historical average over the last twenty years (2000-19) of 3.8%. These figures reinforce the expectation of inhibition by the current level of rates. Additionally, growth is uneven across regions, with some emerging economies, such as Argentina and Turkey facing difficulties.
The resilience of the U.S. economy
2023 has witnessed the resilience of the U.S. economy. According to the second estimate released by the Department of Commerce in late November, the United States' Gross Domestic Product (GDP) exceeded expectations, growing by 5.2% on an annual basis in the third quarter of 2023. However, the current level of rates (5.25%) poses a risk to the sustainability of this economic performance. Investors are beginning to fear that the high-interest rate environment may weigh on corporate indebtedness and the real estate market; potentially leading to a slowdown in the country's growth over time.
Eurozone in the Face of Global Economic Conditions
Economic growth in the eurozone remains below that of comparable countries like the United States or other developed countries. This is primarily due to the Eurozone being a collection of more or less economically robust countries that have pooled their monetary tools through a common currency. Added to this, the conflict in Ukraine has undermined one of the economic and political engines of the zone, Germany, whose economy partly relied on access to cheap gas sources to supply their industries, being highly dependent on Russian exports.
The Eurozone has displayed growth around zero for four consecutive quarters. Current projections forecast growth of only 0.6% for the current year, followed by a modest increase to 0.9% in 2024 and a slight improvement to 1.5% in 2025. This underscores the challenge of making a zone with heterogeneous economies governed by a common monetary policy competitive. However, the Eurozone remains home to highly competitive companies and its financial markets remain closely correlated with other global stock exchanges.
Where do we stand in terms of inflation at the end of 2023?
Global inflation slowed sharply during 2023 (what we call disinflation), falling from 9% to 3% in the United States and from nearly 10% to 2.5% in the Eurozone between January and November. This movement was welcomed by financial markets, central bankers, and all economic players because it allowed households and businesses to regain purchasing power in real terms. Positive inflation is a sign of a healthy economy, however, inflation should not fall much lower than the current levels.
What about the direction of inflation in 2024?
Based on its components, inflation is expected to reach its lowest point in the first quarter of 2024 before rebounding due to technical factors and base effects. Furthermore, wage growth rates in the United States and the Eurozone show that they are currently outpacing inflation. Thus, household purchasing power is increasing, which is traditionally a positive contributor to inflation. We can therefore expect inflation to stabilise and then experience a modest increase in 2024.
If inflation stabilises and global growth continues to hover around 2.5% on an annualised basis, 2024 holds out the prospect of a benign economic environment. This will shift market focus to the actions of central banks.
What direction for repo rates?
It is important to recall that the central bankers' mandate is to ensure the economic and financial health of the currency zone they oversee. Thus, if economic conditions remain benign, central bankers will continue implementing their plan to withdraw the liquidity injected into the markets during the 2010s; known as 'Quantitative Tightening' (QT). This programme has several aspects, including a restrictive monetary policy and therefore high interest rates. Recent statements from central bankers (Fed, BoE, ECB, BoA), suggest a commitment to maintaining elevated policy rates longer than the markets anticipate. In this context, some banks, including Goldman Sachs, consider it unlikely that rates will be reduced before the second half of 2024 unless growth disappoints.
Therefore, we anticipate that the current dichotomy, between market players urging central banks to act faster than planned and central banks that stuck to their QT program as long as the economy allows it, will persist. This may lead to sporadic episodes of market volatility, even though we agree that we have reached the end of the rate hike cycle.
Mechanically, Quantitative Tightening should push global yield curves upward but also have an unfavourable impact on the prices of risky assets, including equities during 2024. The first quarter of 2024 will be key and set the tone for the year for several reasons:
- Corporate results for the last quarter of 2023 and the first quarter of 2024 will be closely watched as they will be the first operational results published taking into account the current rate. If the Q4 2023 and Q1 2024 earnings are positive, investors are likely to push back their expectations of rate cuts beyond 2024. Conversely, investors will signal to central banks that they expect swift action.
- Inflation is expected to rebound in 2024, due to technical factors and an increase in purchasing power. This upward correction in inflation could lead to sporadic episodes of volatility between markets anticipating further rate hikes and the fear that these will suffocate companies. However, given the trajectory of energy prices this winter, global inflation should normalise from Q2 2024.
- 2024 will be a political year with national elections in many major countries, including the United States, and the risk of populist or policy lockdown should not be ignored. This could also give rise to sporadic episodes of market volatility.
In conclusion, it appears that 2024 could be a challenging year for directional assets, particularly if the last quarter of 2023 and the first quarter of 2024 earnings season go well. This reinforces our view that yield structured products, with conditional participation (Protected Tracker, KG + Call) or even protection (Warrant Put, Warrant Short) can play a significant role in the performance of a diversified portfolio in 2024.
Please note that this article is for informational purposes only and should not be considered financial advice or an endorsement of any specific investment strategy.