The nature of economic cycles is changing in parallel with a growing trend towards deglobalisation. I expect domestic economic conditions to be far more important in determining inflation in a particular economy than we have seen over the past 20 years.
Markets and central banks will take time to adjust to this new normal but I think the result will be shorter and more frequent cycles, accompanied by more volatile and, on average, higher inflation. In 2024, I believe this will translate into:
Slowing global growth
There is a high chance that most developed markets will experience at least one quarter of contraction and that some will even face a technical recession, meaning two consecutive quarters of negative growth. However, these downturns should be mild, as households, in aggregate, are supported by rising real incomes despite continued cost-of-living pressures.
Peaking rates
Central banks are keen to indicate that rates have now peaked. As growth slows, unemployment rises modestly and inflation comes down, central banks will probably see an opportunity to cut rates, with the US Federal Reserve (Fed) the most explicit about its rate-cutting intentions.
In my view, that could be a policy error, because the growth slowdown is unlikely to be sufficient to create the slack required to get inflation sustainably back to target.
Divergent monetary policies are likely to become an important theme as central banks have to respond to domestic conditions, meaning, for instance, that the Bank of England or the European Central Bank may not be able to align with the Fed’s lead to the same extent that they have done in the past 20 years.
Growing role for fiscal policy and electoral cycles
A long list of fiscal commitments, ranging from military to climate-transition expenditure, will keep government budgets in deficit, particularly in Europe. As we approach elections, countries will likely loosen fiscal policy further — the US and UK being prime examples in 2024 — even though inflation will likely still be above target.
How will investors react?
With monetary policy in flux and governments consistently increasing their spending commitments, we expect investors to ask for higher risk premia in the coming years, driven by a significantly higher shift in the net supply of government debt.
Debt sustainability may become an increasing concern as governments are consolidating their deficits slowly while central banks, which acted as the buyers of last resort over the past 10 years, have become net sellers.
At the same time, trends in global savings are shifting as emerging markets seem to be less inclined to recycle their surpluses into developed market government debt.
The resulting structural upward pressure on term premia is likely to restrict the potential for long-term rates to rally in the event of a downturn. Conversely, they could potentially continue to sell off at the first signs of a reacceleration of inflation in 2024.
Deglobalisation increases the importance of understanding local drivers at a regional and country level. For instance, small, open economies such as the Nordic countries, which have an over-extended private sector, could follow very different cyclical and policy paths from the US, the euro area and other large economies.
The UK also faces a difficult balancing act between managing structurally higher inflation, a tight labour market and weak growth. Some of the large export-driven economies— most notably, Germany and China — may need to transition to a new domestic-led growth model or risk deflating. And Japan, for so long a source of deflation and savings for the world, could well continue to reflate, ending yield curve control and raising rates in 2024.
A more volatile and uncertain macro backdrop are likely to impact all asset classes and may lead to sudden reversals and greater dispersion, potentially pointing to the need for a more active approach.
John Butler is a macro strategist at Wellington. The views expressed above should not be taken as investment advice.