This article first appeared in Forum, The Edge Malaysia Weekly on December 4, 2023 - December 10, 2023

The trajectory of global finance in 2024 hinges upon one central actor — the US Federal Reserve. When will the Fed start easing?

Markets are anticipating that the Fed will start lowering interest rates by June 2024, resulting in a reduction of up to 100 basis points (bps) by year end, based on an implied prediction of rates using the CME FedWatch Tool. This revised outlook represents a notable shift from April, when the Fed itself believed that a mild recession was on the cards for late 2023.

While recession fears have abated for this year, economists are divided in their opinions regarding the outlook for 2024. More sanguine forecasts, such as Goldman Sachs’ call for 2% real growth, exist alongside cautious perspectives like Nomura’s, which points to a mid-year technical recession involving two consecutive quarters of negative GDP growth, followed by a rapid recovery in the fourth quarter of 2024. Nomura had previously projected the Fed to start cutting interest rates by March but has revised the call for easing to September, while bringing an end to quantitative tightening (QT, or unwinding of the Fed balance sheet). Rate cuts would proceed at a slower pace of 25bps per Fed meeting.

Notably, consumer and corporate sector balance sheets have been sturdier than expected since they earlier hedged their liabilities by taking on fixed-rate borrowings at low interest rates. Despite new mortgage lending rates costing over 7% per annum, the effective rate incurred by most homeowners sits at 3.6%. Bank of America (BofA) credits this lagged interest rate impact on the resilience of the American consumer that has underpinned a strong economy. That lag may have also delayed the transmission effect of the Fed’s monetary tightening.

Across the Atlantic, Europe’s projected real growth for 2024 is slightly below 1%. Recently, German Bundesbank president Joachim Nagel remarked that the European Central Bank’s tightening measures would only have the most significant effect on inflation next year. Therefore, it is necessary to hold interest rates higher for longer. Most economists believe the ECB will coordinate rate cuts with the Fed.

On the other hand, the UK is likely to remain the laggard next year with economic growth of only 50bps. The country is struggling with more structural inflation, while transmission of monetary policy effect has been dulled by corporations reducing their dependence on bank credit where they would be more exposed to interest rate hikes. “Narrower and slower passthrough of rate hikes means more intense financial pressure on firms and fewer households to cut demand,” said BofA, which is why the Bank of England would have to maintain current levels of interest rates for longer. Higher rates mean a stronger pound sterling that helps fight against inflation but cannot be good for the trade account.

In 2024, the focus of the Japanese government bond (JGB) market will centre on whether the Bank of Japan (BoJ) commits to exiting the negative interest rate policy (NIRP) and yield curve control (YCC) measures. This could occur as soon as the monetary policy meeting in January and could see 10-year JGB yields steepen to 1.3% by year end (from current rates of about 75bps). This reversal would close the book on Abenomics, having exceeded the expected inflationary target and achieving real growth of 1.5% in 2024. Should these conditions materialise, the yen should rally after weakening against the US dollar from 130 to 150 this year, as the official interest rates differential narrows between the BoJ and other central banks.

China’s economy is poised to slow from the robust growth seen in 2023, which benefited significantly from the country’s post-pandemic reopening. Growth is projected to moderate to a rate just below 5% next year. There are caveats to this estimate, which is dependent on reversing the real estate drag. Elsewhere, China is grappling with businesses diversifying supply chains away from the country due to trade and geopolitical tensions. In 2023, China has slipped from the top spot to become the US’ fifth largest import partner. Goldman Sachs believes overall growth will taper down to 3% per annum over the next decade, along with an ageing labour force. Geopolitical risks cloud the near-term outlook as the upcoming Taiwanese presidential election in January poses the first potential flashpoint for heightened tensions.

These global factors point toward subdued aggregate demand next year, which has the World Bank forecasting commodity prices to fall 4% in 2024 followed by a 0.5% drop in 2025, with supply pressures in major commodities such as crude oil, grains and metals. However, if further conflicts occur, commodity prices could be in for periodic shocks.

Curiously, economists anticipating interest rate cuts next year appear to think that the yield curve inversion will persist, with long-dated yields being lower than short-dated ones. One notable dissenting voice belongs to veteran bank analyst Chris Whalen, who predicted the US subprime mortgage crisis back in 2008. Writing in the Institutional Risk Analyst blog, he said: “Our big worry is that short-term interest rates may fall in 2024, but long-term interest rates will rise due to the Treasury’s vast deficits and mounting interest expense … Because the Fed’s balance sheet is already polluted with low-coupon Treasury and mortgage debt, the central bank has little remaining flexibility to respond to a large bank failure or other contingency.”

It was less than a year ago that Silicon Valley Bank suffered a “Twitter bank run” when its depositors fled upon discovering sizeable unrealised losses the bank was carrying on its long-term Treasury and securities holdings. Cumulatively, US financial institutions are shouldering more than US$550 billion in unrealised losses as at 2Q2023, according to the Federal Deposit Insurance Corporation (FDIC). Should Whalen’s call for a bear steepening event transpire, these losses could magnify, posing a key risk to the stability of the US (and global) financial sector.

We were all relieved when the expected downturn failed to materialise in 2023. Sturdy US growth amid slowing inflation has markets counting its luck and betting on a soft landing. But good fortune comes with mental preparation. As former Intel CEO Andy Grove famously said, “Success breeds complacency. Complacency breeds failure. Only the paranoid survive.”

Good luck in 2024.

Tan Sri Andrew Sheng writes on global issues that affect investors. Tan Yi Kai is a Malaysian multi-asset trader based in Hong Kong.

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