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Inflation has been the driving macroeconomic force for nearly two years, and its effects were largely thought to have peaked by autumn 2023; however, many are still on their toes, watching for further effects in 2024 and beyond, especially on the US economy.
Some of the positive effects for investment teams have so far included good investment returns, while the negative effects have been a cost-of-living crisis, which has seen people cut back on essentials and companies try to save money on their coverage.
Come 2024, the question for many in the industry is whether the US economy will enter into a period of disinflation or deflation.
“Barring any new 'risk premium' event in the energy sector, we'd share the view
that the steady rate of disinflation in the US will continue through 2024."
With the US presidential election looming next autumn, the Biden administration is keen for good news on the economy – and the actions of the Fed have been increasingly politicised.
“Barring any new 'risk premium' event in the energy sector, we'd share the view that the steady rate of disinflation in the US will continue through 2024, a continuation of the steady progress made in this area throughout 2023,” said Joe Tuckey, Argentex’s Head of FX Analysis. “Inflation is falling faster than the Fed had thought.”
According to the US Bureau of Labor Statistics (BLS),“the all-items index rose 3.2% for the 12 months ending October, a smaller increase than the 3.7% increase for the 12 months ending September.”
This, as Tuckey said, was a smaller than expected increase. It was a view backed by analytics company Morningstar, which said it “expect[s] inflation to average 1.8% from 2024 to 2027—undershooting the Fed’s 2% inflation target”, in a recent report.
“But if inflation proves stickier than expected, the Fed stands ready to induce a recession to bring inflation down to 2%,” the Morningstar report added.
“Continued fiscal expansion with real GDP growth already above trend prevents
the necessary economy cooling to bring US inflation under control.”
Meanwhile, in Europe, politicians have largely stuck to the narrative that the worst of inflation’s rapid ascent in 2022-2023 is over, with some beginning to instigate minimum wage rises and tax cuts.
In November, Swiss Re Sigma said that the impact of economic inflation on claims is forecast to ease further over the course of 2024 and 2025, but could still heavily affect the insurance industry globally. “Non-life insurance profitability will improve to around 10% return on equity (ROE) in both 2024 and 2025, well above the 10-year average of 6.8%," said the report on its findings. “While the sector will continue to strengthen its profitability, mainly driven by improved risk-adjusted pricing as well as higher investment returns, it is not yet expected to earn its cost of capital in 2024 or 2025 in most markets as economic inflation will continue to have a negative impact on claims costs,” said Jérôme Jean Haegeli, Swiss Re's Group Chief Economist.
A November 2023 report from Dutch investment firm Robeco said it believed that “2024 will be the swan song for immaculate disinflation”.
The report, ‘2024 OUTLOOK Goldilocks: Exit stage right’, painted a fairly healthy picture of the US economy in 2024; however, it came with caveats and with a warning of Japanisation of the economy. “Next year will likely see stagnant G7 economies as high real rates start to dent real activity, exhausting consumer spending power and crowding out corporate investment activity,” it said. While this may sound extremely negative, the report believed that the US would be largely spared further spikes of inflation over the course of 2024.
“Continued fiscal expansion with real GDP growth already above trend prevents the necessary economy cooling to bring US inflation under control,” it said. “Worries about fiscal slippage have partially contributed to the recent steepening in the US yield curve. Any further downgrades in the US credit rating – due to fiscal slippage or stickier-than-expected core inflation (2.6% for core PCE inflation by 2025) – could keep bond traders on edge.”
However, it also warned that the labour market could be a sticking point for the trajectory of inflation. “Central banks may be reluctant to cut amid a sticky core inflation backdrop,” it said. “We therefore expect to see stagnant developing market economies in 2024 as the thrust of a hot labour market peters out. However, even an uptick in unemployment consistent with what leading indicators at this juncture suggest could still see core inflation remain stuck around 3% in 2024.”
Goldman Sachs Research said that it expected the global economy to outperform expectations in 2024, just as it did in 2023. “Our main concern is that as higher rates slowly work their way through the system, the dispersion in credit will only increase,” it said.
“As the macro-economic backdrop worsens and slowing activity tempers inflation expectations, rates and credit markets have reacted very positively to the hope that the Federal Reserve may change to a more dovish stance,” said Andrea Seminara, CEO of Redhedge Asset Management. “While it is clear that the markets’ overly bearish view on rates when 10Y UST was near 5% and 10Y GDBR at 3% was unjustified, we believe it is equally misguided to think that now, just because rates are a bit tighter, that everything is hunky-dory,” he said.
As mentioned by Seminara, much of inflation trajectory in the US rests at the hands of the Fed and its moves next year.
“With disinflation already in place, the question is 'when', not 'if',
the Fed will cut rates.”
Retail investor giant Vanguard said over the summer that its models showed the Fed not being in a position to cut interest rates until the middle of 2024.
Others, however, disagreed; similar to Goldman Sachs, they believed a cut was likely next year. “We are of the view that the Fed will make cuts next year,” said Tuckey. “With disinflation already in place, flatlining retail sales, and the spectre of weaker employment data into 2024, the question is 'when', not 'if', the Fed will cut rates.”
Tuckey added that futures markets foresee up to 100 basis points of cuts (1%), which could easily be the case. “The more difficult issue will be the timing of the first cut, which may get pushed back later than the market thinks, depending on inbound US data,” he said.
Tuckey was reticent as to whether these changes would have a definitive effect on these markets. It would depend on numerous other variables, he said. “If there is a 'soft landing' in the US with the 1% of rate cuts, we'd expect this to support US equity indices, which would usually be an environment that would drive a weaker dollar.”
However, the fate of the dollar would also come in the context of the rate cut pace and trajectory of other G10 central banks, he added. For example, the dollar would only weaken if other central banks cut less than the Fed did. “There are also other idiosyncratic issues to acknowledge, such as the Presidential election later in the year,” he said. “In general, though, much like the first half of 2023, we do see a landscape in which the dollar may continue to weaken versus many G10 peers over the next few months.”
2024 is likely to be a fraught year, with investment teams watching market minutiae closely for signs of further trouble. However, the higher-for-longer environment hasn't been all bad, with bumper returns seen as a kind of consolation prize.
Nevertheless, there will be additional pressure on the Fed – from both sides of the US partisan divide – to maintain rates in an election year, while policymakers will likely advocate for lower rates, hoping to maintain them.
