Navigating Macro Currents in 2024

Markets interpreted the Fed’s communications around a potential peak in U.S. interest rates as opening the door to sharp rate cuts as inflation falls. We expect inflation to ease close to 2% in 2024 as consumer spending normalizes from the pandemic and goods prices fall. So beyond the early January jitters, the risk rally could extend – until the risk of inflation resurging comes into view later this year, as we expect. Markets pricing in a perfect outcome is a big macro bet, in our view. A soft economic landing is possible, but the range of potential outcomes is wide in the new regime of greater macro and market volatility. That’s why we’re ready to be nimble and selective on our six-to-12-month tactical horizon.

Case in point: Falling U.S. goods prices are dragging down inflation as pandemic-driven swings in spending unwind. Yet a tight labor market is driving stubbornly high wage growth, as seen in the December jobs data. We think that means inflation is set to rollercoaster back up near 3% in 2025 as the goods price drag fades. We see geopolitical fragmentation bolstering inflationary pressures in coming years, too. That’s why we think the Fed may not be able to deliver the rate cuts markets expect, even with growth moderating as consumers exhaust their pandemic savings and government spending on defense and student loan forgiveness tapers off. The big question for risk assets: when they might start to reflect this outlook in 2024.

In fixed income markets, we see more volatility ahead partly as inflation’s persistence becomes clearer. Plus, we see markets grappling with where neutral rates – the interest rate that neither stimulates nor restricts economic activity – are settling after the pandemic. We think neutral rates are higher in both the U.S. and Europe, partly due to looser fiscal policy and the investment demands tied to the low-carbon transition. We also think investors could demand more compensation for the risk of owning long-term bonds given rising public debt and a more uncertain inflation outlook.

Bottom line: We get granular to navigate macro uncertainty, favoring Japan, tech and industrials in stocks. We also went tactically neutral long-term Treasuries in October and we keep our overweight to short-term Treasuries. Yields may swing in either direction as markets keep reassessing the outlook for policy rates.

Market backdrop

The S&P 500 fell about 2% last week after the 24% surge last year, while U.S. 10-year yields climbed back to around 4% and rose more than 25 basis points from the December low. The Fed’s December meeting minutes highlighted the easing of financial conditions, adding to the risk asset jitters to start the year. The end-2023 market momentum could persist. But the December U.S. payrolls report confirmed ongoing wage pressures may ultimately disappoint the optimism on inflation.

Tracking five mega forces

Mega forces are big, structural changes that affect investing now – and far in the future. As key drivers of the new regime of greater macroeconomic and market volatility, they change the long-term growth and inflation outlook and are poised to create big shifts in profitability across economies and sectors. This creates major opportunities – and risks – for investors. See our web hub for our research and related content on each mega force.

1. Demographic divergence: The world is split between aging advanced economies and younger emerging markets – with different implications.
2. Digital disruption and artificial intelligence (AI): Technologies that are transforming how we live and work.
3. Geopolitical fragmentation and economic competition: Globalization is being rewired as the world splits into competing blocs.
4. Future of finance: A fast-evolving financial architecture is changing how households and companies use cash, borrow, transact and seek returns.
5. Transition to a low-carbon economy: The transition is set to spur a massive capital reallocation as energy systems are rewired.

Granular views

Six- to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, January 2024

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this and, importantly, leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but is creating more space for alpha.

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