As we approach the end of 2023, financial markets are at an important junction. Major developed market central banks have paused their rate rises and there is considerable uncertainty about what happens next.
As inflation has come down meaningfully in the past 12 months, there is a growing view among investors that the cycle of interest rates hikes is at an end, even though inflation remains above central banks’ target level. Markets are currently forecasting that we may see rate cuts next year. However, policymakers have indicated that rates may remain at these elevated levels for some time.
The divergence between the expectations of investors and central banks’ apparent commitment to tighter monetary policy is one of the main sources of uncertainty in markets at present.
At the time of writing, the prevailing market view appears to be that policymakers, primarily in the US, are on track to deliver a ‘soft landing’, bringing inflation down without causing a major recession. This view reflects the fact that, despite one of the most aggressive and rapid rate hiking cycles in history, the global economy has held up well so far.
But there are signs that demand is softening and economic activity is weakening. This sets up one of the biggest debates for 2024: will policymakers keep rates ‘higher for longer’ if we see growth slow significantly or unemployment rise?
Indeed, in these pages Jim Leaviss, CIO Fixed Income, suggests that the more likely scenario for next year is not a soft landing, but a slowdown followed by central banks cutting interest rates. In his view, the current environment offers opportunities in government bonds and duration (interest rate risk).
Meanwhile, despite a high degree of market volatility, and contrary to popular opinion coming into 2023, most equity markets look to be ending the year firmly in positive territory, with sentiment buoyed by the prospect of ‘peak interest rates’.
As we head into 2024, from a valuation standpoint, the UK and Europe are looking more compelling than US equities in aggregate following the strong index returns in 2023. But as Fabiana Fedeli, CIO Equities, Multi Asset and Sustainability, points out, outsized returns in the US market have been highly concentrated, which means that there could still be very good opportunities there for active investors who are willing to dig a little deeper.
In addition, after a few months of return convergence, we are starting to see a return to greater dispersion across stocks globally, even within the same sectors, providing support to an active investment approach as we head into 2024.
Importantly, a potential economic downturn could see equity markets come under pressure next year, so selection will remain key. By focusing on companies that are able to benefit from longer-term structural drivers rather than those with more cyclical exposure, Fabiana suggests that investors can continue to find attractive investment opportunities.
Dave Fishwick, Head of Macro Investment, agrees that, should we see a structural shift to a higher rate environment, active investing could have an increasing role to play going forward. In Dave’s view, active managers could benefit from elevated dispersion in both equities and fixed income, while in-depth analysis will once again come to the fore as investors look to distinguish between the winners and losers of tomorrow, in an increasingly competitive environment with a potentially tougher economic backdrop.
Paths beyond the peak
As we approach ‘peak rates’, we are arguably nearing the end of the beginning of this economic cycle. What happens next is not clear. Besides the economic uncertainty, next year multiple countries are due to hold elections, most notably the US but also India, Mexico and South Africa. According to Bloomberg Economics, voters representing 41% of the world’s population will go to the polls in 2024. Politics and geopolitical issues such as the Israel-Gaza crisis and US-China tensions could potentially add to the complex macroeconomic backdrop and cause further disruption to volatile financial markets.
The investment landscape is challenging. However, we hope these perspectives provide some clarity on what might lie beyond the peak and highlight potential paths to help you prepare for the year ahead.