Outlook 2024: Rate cuts at last

Key takeaways:

• Investors will face slowing global growth, ongoing falls in inflation, and geopolitical risks in 2024
• We think a sharp US downturn will be avoided, with interest rate cuts in the second half; the eurozone could stage a slightly larger recovery. China’s growth will slow, and Japan will see an end to negative interest rates
• We maintain a neutral exposure to risk in multi-asset portfolios, balancing the positives from recent economic resilience and disinflation against the expected delayed effects from higher borrowing costs
• Peaking yields and a soft economic landing should be a positive environment for high quality fixed income. We see gains for the S&P 500 being driven by earnings growth.

When will central banks be able to cut rates?

On balance, we think headline inflation should fall to between 2-3% in 2024 in many developed economies, above typical 2% inflation targets but enough to facilitate rate cuts in the second half in the US and mid-year in the eurozone.

How far will rates be cut? The global economy has changed since the last cutting cycle in early 2020, including some factors that suggest a slightly higher inflation rate. Government spending has risen, in part to fund green investments and redirect supply chains. These long-term transitions are driving a global capital expenditure boom. Meanwhile, labour markets are tight. The ‘neutral’ level of interest rates for central banks – one that neither drives nor restrains growth – may now be higher.

Growth constrained, but reaccelerating later in 2024

After such aggressive monetary tightening, avoiding at least a period of below-trend global growth looks improbable. The US economy will slow in 2024. Signs of stress are evident in falling business investment, small companies struggling to cover interest payments, commercial real estate, credit card and car loan delinquencies. Wages are now barely growing in line with inflation. Rising interest payments are taking a bigger bite out of household incomes. In the eurozone, where reliance on bank lending is higher and mortgages refinanced more often, the economy has been hit more quickly by higher rates and should stage a limited rebound in 2024.

Read also: US economic outperformance is poised to narrow

Politics back at the forefront: US elections

Policy discourse will become even more combative in a tight race for the White House. It will be a difficult year for an incumbent President, given headwinds from a slowing economy, rising joblessness, and foreign policy. The election will raise questions over potential tax cuts, increases in protectionist trade policy, support to Ukraine, and the sustainability of the fiscal deficit. We see little immediate appetite among Democrats or Republicans to tackle rising federal debt. There is also broad consensus in maintaining a competitive and adversarial China policy.

Risks to monitor: geopolitical and financial instability

Intensified global competition and conflict puts a strain on policymakers’ capacities. Supply chains and investment flows are being redrawn globally. US-China tensions, including over Taiwan, Russia’s war with Ukraine and the Israel/Hamas conflict are all potent sources of risk. Defaults on commercial property loans are a potential source of vulnerability across a range of financial institutions. Slowing growth also poses issues for the sustainability of government finances. 

Interestingly, rising bond yields have not yet led to a sharp widening in credit spreads, or the premium that companies pay on their debt over sovereign yields. This has helped contain defaults, bankruptcies, and in turn, job losses. Our base case remains that a limited deterioration in credit conditions should continue to shield companies, jobs, and growth from a sharper slowdown.

Narrow path to a soft landing

Overall, markets remain caught between higher-rates-for-longer and recession fears. Our baseline view going into 2024 remains that US demand will slow, pushing growth down, helping the disinflationary process and allowing the Fed to start cutting policy rates back to neutral in the second half. But this is a narrow path with risks on either side.

Historically, pauses in monetary policy tightening cycles have tended not to last long. In turn, the performance of equity markets largely depended on the subsequent trajectory of inflation and particularly growth. When inflation was under control and growth stabilised, equities did well and policy rates did not move much (e.g. 1995, 2006). When inflation was problematic and/or recession followed, equities suffered and monetary policy changed more dramatically, whether upwards or downwards (e.g. 1981, 2000).