Asset Management: Monthly Macro Insights - February 2024

Regional divergence remained significant at the end of 2023. Although the impacts of high interest rates and the withdrawal of fiscal support are expected to weigh on growth in 2024, investors are keeping their sanguine outlook as they foresee fast interest rate cuts. Yet, resilient labour markets and renewed pressures on supply chains could require a tighter monetary policy stance than expected, upsetting investors’ high hopes.

The US mask a lacklustre H2-2023

The US exceptionalism continued in late 2023 and the main engines were once again household consumption and government expenditures. Conversely, the eurozone economy stagnated. In China, the first data for 2024 point at an economy still fragile and it seems that more support from Chinese authorities is needed especially as deflationary pressures are a key challenge for growth this year.

Strong labour market could derail the disinflation trend

Amid favourable global supply chain improvements, lower commodity prices and a tight monetary policy, inflation has been falling for the past few quarters. However, the risk of persistent core inflation, requiring a tighter monetary policy stance, seems to be highly underappreciated by investors. Major shipping companies have stopped using the Red Sea, raising shipping costs sharply and lengthening delivery times. Combined with the ongoing war in Ukraine, it risks generating fresh adverse supply shocks, with spikes in food, energy, and transportation costs. In addition, the conflict in Gaza and Israel could escalate further into the wider region, which produces about 35 per cent of the world’s oil exports.

The tightness of most labour markets is also a cause for concern. In the eurozone, the unemployment rate stayed at a record 6.4 per cent in December and data regarding wages seem critically important in deciding when to begin monetary easing. In the US, job openings unexpectedly rose in the last two months of 2023, suggesting that demand for workers remains solid. This could lead to persistently high core services inflation. Indeed, wage increases remain significant as the tight labour market give workers strong bargaining power while businesses have high pricing power thanks to a buoyant economy. In this context, Fed Chair Powell reframed his message by adopting a much less accommodating tone compared to the December meeting where he surprised market participants by suggesting that rate cuts were clearly on the agenda. So it appears the Fed will not act as a lone ranger.

In sum, core inflation is still above target in most countries and unit labour cost growth generally remains above levels compatible with medium-term inflation objectives. Correspondingly, it is highly uncertain that the inflationary episode that began in 2021 will end soon, and the significant monetary easing that is expected by investors might well be misplaced.