2023 ended with a strong equity rally (+4.7% in December for the MSCI AC World index in US dollar terms) driven by hopes of a rapid cut in key rates by the US Federal Reserve. As early as the second trading day of 2024, this rosy mood vanished.
With some investors still on vacation, we should not overthink the significance of the new year’s first few days of trading – after all, given thin trading volumes, the market movements in the last week of 2023 were not really a reliable bellwether, either.
Whatever we wish for, though, one thing seems likely to hold fast as we move into 2024. For better or worse, we think investors will continue to analyse (and sometimes over-analyse) every change in the US Federal Reserve’s (Fed) rhetoric. Economists, for their part, look set to continue to follow (arguably sometimes too closely) market-priced expectations.
What central bankers are saying
Unsurprisingly, discussions during central banks’ monetary policy committee meetings focus on growth and inflation rather than on any specific timing of policy rate cuts.
This was clear from the Minutes of the Federal Open Market Committee (FOMC) meeting on 12/13 December, published on 3 January, which pointed to an ‘unusually high degree of uncertainty’ among FOMC members about the economic outlook. They deemed it ‘appropriate’ to maintain a restrictive monetary policy, although some were concerned about ‘downside risks to the economy that would be associated with an overly restrictive stance.’
The Federal Reserve of Atlanta’s GDPNow running estimate of fourth quarter GDP growth stood at 2.5% in early January, well above the consensus among market economists.
Richmond Fed President, Tom Barkin, a voting FOMC member this year, said on 3 January that the committee’s March decision was still ‘a long way away’ and that he usually tries ‘not to prejudge meetings.’ He did not rule out the possibility of further increases in key rates and reiterated that inflation and growth data will guide monetary policy decisions.
The day prior, the Governor of the Bank of Spain had said pretty much the same thing: “The question of how long it will be necessary to keep interest rates at [the] current level before starting to reduce them will depend on the future evolution of data, in a context in which uncertainty continues to be high”.
At the very end of 2023, Robert Holzman, governor of Austria’s national bank, declared that ‘there is no guarantee of rate reductions for 2024.’
What about economic data?
In the US, activity rebounded at the end of 2023 in the housing sector (housing starts, existing home sales) and manufacturing sector (industrial production, ISM index). However, a closer look suggests the improvement may be fragile.
On the one hand, homebuilders’ sentiment rose only modestly in December after a run of four declines. On the other, while the recovery in activity in November among car manufacturers (after two months of strikes) should continue in December, we do not think it likely to last much beyond that: the manufacturing purchasing manager’s index (PMI) fell in December to 47.9, its lowest since June, driven by a decline in new orders.
With central bankers repeating the mantra that their next decisions will be ‘data-dependent’, it is worth looking at the latest available economic indicators.
According to PMI surveys, global growth showed signs of weakness at the end of 2023. The Global PMI Manufacturing Index fell from 49.3 to 49 in December, having hovered around this level since last August.
The index is below 50, indicating a contraction in manufacturing, for 22 of the 29 countries in which the survey is conducted. It has fallen hardest in developed economies. Companies are reporting further job cuts in the face of the continued weakness of output and new orders.
In the US, while the ISM purchasing managers’ survey surprised to the upside with the manufacturing index rising from 46.7 to 47.4, it should be noted that anything below 50 for the manufacturing index indicates a contraction of the sector.
In the eurozone, the composite PMI index remained stable at 47.6 in December (a better result than in the first estimate). The average index level in the fourth quarter was 47.2 (47.5 in the preceding quarter), which corresponds to a recession (after GDP contracted by -0.1% in the third quarter). The worsening of the employment component supported this.
A turbulent year ahead
The Fed’s last monetary policy committee in 2023 offered investors the ‘pivot’ they had long awaited. By indicating that the sequence of policy rate hikes was over and that a rate cut might be considered as early as the first half of 2024, Fed Chair Powell fuelled a year-end stocks and bonds rally.
Faced with a sharp slowdown in inflation and signs of slowing activity, still tentative in the US, investors began to anticipate numerous rate cuts. The perfect ‘soft-landing’ scenario has gained ground as more investors appear convinced that inflation has been defeated without causing a recession.
The recent equity rally is strongly linked to expectations of rate cuts early in 2024. Short term, this theme could continue to play. The tightening cycle is likely over, which would spell a major change for many asset classes.
Given the sharp December bond rally, we expect (possibly volatile) adjustments in yield levels at the start of 2024. We believe it apt to start 2024 with more balanced portfolio positioning by raising our equity exposure to neutral (retaining some medium-term caution) and reducing the long positioning of our bond bucket after profit taking. Ongoing geopolitical risks and the US presidential election in 2024 will likely fuel some nervousness.