The global economy outperformed some of the most optimistic forecasts in 2023 despite the sharpest synchronised monetary tightening (increase in interest rates) from central banks around the world, ongoing military conflicts, an energy crisis and a US regional banking crisis.

The private sector proved to be resilient thanks to a strong labour market and consumers spending their excess savings from the Covid period. Corporates had healthy balance sheets with debt termed out (increase the amount of fixed interest loans).

Then, towards the end of the year, equity markets rallied into Christmas with increasing expectations of Fed cuts (the US Central Bank cutting interest rates) as inflation appeared to be under control.

This markets outlook piece provides university students and CFA candidates, who have a desire to have a career in investments, an overview of what’s in store for 2024. It is not intended to be a forecast but for you to understand the current market dynamics and come up with your own view.

The Economy’s Remarkable Resilience

The private sector (households and consumers) has weathered the monetary tightening cycle surprisingly well. It has been a self-reinforcing dynamic between strong consumer spending and tight labour markets i.e. strong spending has supported the demand for labour, while strong labour markets and wage growth have supported consumer spending.

Much of the strong consumer spending can also be attributed to significant excess savings from Covid-period stimulus, but the significant amount of excess savings has largely depleted – over 80% of consumer excess savings are already gone (Source: JPM).

Furthermore, the effect of rising interest rates on corporates and households has been less impactful as both took the opportunity during Covid to lock in ultra-low interest rates, and hence the transmission mechanism of monetary policy is now less effective.

Is Inflation Now Under Control?

Most developed market economies have seen substantial declines in inflation compared to their peaks as supply chains normalise and inventories improve however most of the declines in inflation have stemmed from falling goods prices rather than non-shelter services inflation (mostly driven by wages). While the labour market remains tight, wage growth is also coming off from their peaks.

The Signs of Weaker Growth and the Hopes for a Soft Landing

With interest rates still in restrictive territories, leading economic indicators are now pointing to weaker growth e.g. low business expectations, bank lending standards. However, with declining inflation, markets have priced in central banks cutting interest rates in 2024 and engineering a soft landing (economy slowing but not a recession).

Historically, central banks have not had a good track record of engineering a soft landing. How do you think the central banks will react? Will the “last mile” of the US inflation remain too stubborn? What do you think the economy will do in 2024 and, more importantly, how will the market react?

Author: Frank Li, Portfolio Manager, Diversified Portfolios at MLC.