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We tend to think about the economy in binary terms. Recession: yes or no? Will markets be up or down? Will interest rates rise or fall? The answer to the latter question, at least in the US, appears to be “fall,” as the Federal Reserve held rates steady during its meeting last week while hinting that we could see as many as three rate cuts next year. That has, of course, buoyed stock markets, which have gone long on the soft landing story. But economic reality in 2024 is likely to be far less binary, and much more nuanced, than many market participants and policymakers believe.
There are three reasons for this. The first and most obvious is that the pandemic and the policy response to it has made it very difficult to predict where the US and global economy will be based on old models. Employment, wages and other key metrics are refusing to follow historic trends in many places. Second, decoupling and the rise of industrial policy have introduced a new dynamic into fiscal policy and trade relations — one that will continue to play out no matter who wins the US presidential election next year.
And third, there is an ongoing interest rate arbitrage effecting business and consumers that still has years to run. Yes, rates are now far higher than they have been for several decades, and even if we get some cuts in 2024, that will still be the case. But many borrowers locked in cheap financing before inflation hit and rates rose. Those costs will reset over time, not all at once, which means we may see more slow moving, unpredictable disruptions, rather than a single big event.
Take the first issue, namely that of the pandemic and the massive fiscal stimulus that followed. On the one hand, the fact that Covid savings, particularly in the US, have been largely spent down from their peak, coupled with somewhat slower job growth, validates the idea that we could see less inflation and a slightly weaker economy in 2024.
But on the other, as JPMorgan chief executive Jamie Dimon pointed out last month, the push for re-industrialisation and energy security that has followed the pandemic and Russia’s war in Ukraine is inherently inflationary. “I think quantitative easing and tightening and these geopolitical issues can bite,” he said at the New York Times’ DealBook Summit, where he warned that both higher inflation and recession were still possibilities.
Add to this the fact that the pandemic and its responses weren’t synchronised, as monetary and fiscal policy were after, say, the financial crisis of 2008, and you simply have a much more complicated global environment for accurate policymaking. For years, asset classes and geographies moved in lockstep. Now, that’s changing, and will likely change more as central bankers in different regions take different decisions.
Investors are certainly swooning over Fed chair Jay Powell’s recent messaging about rates, but should they? The Dow and the S&P 500, not to mention the Nasdaq, are wildly overvalued by numerous metrics, as we all know.
Furthermore, there are unpredictable political risks looming on the horizon right now, including two hot wars in Ukraine and Gaza, as well as the possibility of more trade and tariff tensions in the year ahead. I wouldn’t be at all surprised, for example, to see difficulties erupt between both the US and China, and Europe and China, around things such as steel, EVs, clean tech or rare earth minerals.
The problem is that all these regions are trying to produce more goods locally right now. Long term, that’s a good thing, because we need more diversified and resilient supply chains, as well as a lot more clean technology at scale. But there’s little doubt that it is inflationary in the short to medium term.
China is desperately trying to expand its own global manufacturing footprint as a way of both hedging against further western decoupling and mitigating the slowdown from its housing crisis. That raises the risk that we will see China flooding global markets with more cheap goods. European Commission President Ursula von der Leyen made it clear at a recent meeting in Beijing that she was concerned about such Chinese product dumping.
We will hear the same in the US in the coming year in advance of the presidential election. In the past, the US and EU might simply have hoovered up low cost Chinese items and let jobs and investment dollars in key sectors go elsewhere. That is no longer a political possibility. If I had to make one firm bet for 2024, it would be that we are about to enter an even thornier global trade environment.
The final reason the year ahead will be difficult to predict is that the shift in interest rates and the ramifications for both consumer and companies won’t be felt all at once. Instead it will become clear over time. As I’ve written in the past, the fact that mortgage rates are now near 8 per cent in the US has not had the predicted impact on housing prices because so many owners locked into lower rates over the past 15 years. There will be a reckoning as those reset. But it will happen over the course of years, possibly at unexpected moments.
The same goes for companies. We were supposed to see massive corporate defaults this year, but we didn’t get the tsunami that was predicted. That’s because many big companies locked in cheap funding before rates began to rise. Maybe they’ll fall again in 2024. But even if that happens, the results won’t be binary.
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