- Underlying strength in the U.S. economy means the Fed will likely remain patient in cutting rates, as indicated in the January Fed statement.
- The Chinese equity market underperformed in January, dragging continued weakness in property and household sentiment, with the March NPC meeting being a focus for policy direction this year.
- The recent escalation in conflicts in the Middle East revives concerns on supply chain disruptions and higher energy prices, posing a key risk for growth and central bank policy globally.
2024 started out how 2023 ended. The U.S. Federal Reserve (Fed) continues to make it clear that it is not rushing to cut rates, considering strong growth and job numbers. The Chinese central bank relaxed monetary policy further to support the economy. The situation in the Middle East is slowly escalating, with the U.S. launching airstrikes against Iranian forces in Syria and Iraq. Following two primaries in the U.S. presidential race, a re-run of 2020 Biden versus Trump seems to be the most likely scenario for the upcoming vote on November 5. The U.S. equity market progressed, along with the S&P 500 hitting record highs. In contrast, Asian markets’ struggles continue, with Chinese markets still under pressure. Overall, January’s market performance was broadly in line with our view that a stock-bond portfolio should outperform cash in a meaningful way in 2024, with the Fed’s pivot taking place later in the year.
Not rushing into it
The Fed’s first meeting of 2024 went as we expected. It kept its policy rate unchanged at 5.25%-5.5%, and both the statement and Fed Chairman Jerome Powell’s press conference reiterated that it is in no rush to cut rates and the current data is simply not sufficient to justify relaxing policy in March. Nonetheless, on February 2, the futures market significantly cut back on the chance of a 25bps cut in March from 75% probability to just 22%. Even so, it is still expecting a total of 130bps cuts in 2024, compared with the Fed’s 75bps in its December forecast. The Fed’s patience is well justified. Inflation has indeed come off, with the December personal consumption expenditure (PCE) deflator falling to 2.6% year-over-year (y/y). The core PCE deflator fell to 2.9%, below 3% for the first time since March 2021. However, the job market is still red-hot. In December 2023 and January 2024, the U.S. job market added 686,000 jobs and hourly earnings accelerated 4.5% y/y. The Atlanta Fed’s GDP nowcast suggests the economy is growing at around 4% pace. All these factors could give the Fed some time to wait and see.
We think the fine-tuning of expectations should continue to keep U.S. Treasury (UST) volatility high. The 10-year UST yield went through as a 38bps swing between January 25 and February 1. Overall, we expect bond yields to gradually shift lower in 2024 with softer economic data. Meanwhile, the equity market seems less concerned about the Fed’s caution in its policy pivot. The S&P 500 was up 1.6% in January. Benign corporate earnings are helping to offset some delay in monetary policy loosening.
In contrast, the Chinese central bank cut the required reserve ratio (RRR) by 50bps to pump more liquidity into the system. However, both the onshore and offshore equity markets remain depressed, with the CSI300 index down 6.2% and MSCI China down 10.1% in January. As we have argued in the past year, successive interest rate and RRR cuts have not boosted credit growth, as business and household confidence remain subdued. China’s 4Q GDP number, at 5.2% y/y, was respectable but not spectacular. Households still lack the confidence to invest in properties, and this is likely to weigh on the broader economy in 2024. One piece of good news is that export performance is starting to improve. December 2023 export growth came in stronger than expected at 2.3% y/y.
As always, expectations are being built on more aggressive policy to be announced around the National People’s Congress (NPC) in March. If true, this could be an important trigger for the stock market to rebound, fueled by cheap valuations. However, we did experience several rounds of hyped market expectations going into key meetings, only for the eventual policy support to be more conservative than what investors were looking for.
Supply side shocks from the Middle East
The Israel-Hamas conflict has slowly evolved into a more complex conflict in the region. The Iran-backed Houthis militia group attacked ships in the Red Sea. This critical sea route, connecting Asia with the Mediterranean Sea, is responsible for around 15% of global seaborne trades. These attacks mean that ships have to go around southern Africa, adding 12–15 days to the journey. This will add costs to the global supply chain. More importantly, if the current conflict further escalates to the Strait of Hormuz, where around 21% of global petroleum consumption flows through, then global energy supply could come under pressure, leading to higher energy prices. Given the high weight of food and energy in their inflation baskets, emerging markets may need to raise rates more in order to maintain currency stability.
If this scenario happens, one question is whether central banks will consider higher commodity prices a challenge to inflation or a tax on growth? For developed economies, it is probably more of the latter, and central banks may just hold onto their current high rate environments for a bit longer. For emerging markets, given the high weight of food and energy in the inflation basket, they may need to raise rates more in order to maintain currency stability.
Overall, global economic and policy development is broadly in line with our 2024 outlook. In the near term, we could see investors finally converging toward the Fed’s stance of taking its time to cut rates. In Asia, the potential for strong export performance is yet to be fully recognized. January Purchasing Managers' Index for Taiwan, South Korea, and ASEAN continues to improve. South Korea’s exports expanded by 18% y/y in January, the strongest performance since May 2022, supported by semiconductors and exports to China.
On fixed income, yield continues to be a key source of return at this point. Credit spreads, especially in the U.S., are already pricing in low default. Hence, it is less likely to be a potent source of return. Duration gains from risk-free rates should eventually be rewarding when central banks start to pivot toward loosening policy.
Over the course of 2024, we still see this policy pivot as a benefit to stocks and bonds, especially if the Fed is taking a preemptive stance in maintaining growth, instead of cutting rates in reaction to financial stress or a sharp downturn.
- 4Q23 U.S. real GDP beat market expectations, increasing at an annual rate of 3.3%, driven by strong government and consumer spending. Encouragingly, despite the strong growth number, core PCE inflation remained stable at 2.9% y/y in December. Against this backdrop of resilient growth, strong labor market, clear disinflation trends and easier monetary policy ahead, consumer confidence hit a two-year high in January. The underlying strength in the economy prompted Chairman Powell to warn against market expectations of a March rate cut. It also allows the Fed to focus on its inflation mandate rather than worry about unemployment. A cut will likely only come when the committee is confident in achieving 2% inflation.
(GTMA P. 24, 25, 31)
- Japan also came into the spotlight in January with the Bank of Japan (BoJ) meeting. Although the BoJ kept monetary policy unchanged, BoJ Governor Kazuo Ueda gave clear hints of an end to negative interest rates. Core consumer price index (CPI) was above the BoJ’s 2% target for 21 months but has mostly been cost-pushed. With the softening of consumption data, the sustainability of inflation is the focus going forward. On that, the BoJ revised downwards its FY24 forecast for core CPI from 2.8% to 2.4%.
(GTMA P. 14, 15)
- China’s 4Q23 GDP and 2023 GDP both grew to 5.2%, meeting Beijing’s 5% target. However, the December activity data continued to reveal a significant drag from the property sector, with retail sales remaining weak and deflationary pressures persisting. Although we are starting to see a modest recovery in exports, broader economic momentum can only pick up with stronger policy support. Thus, the March NPC meeting will be key to watch.
(GTMA P. 5, 6, 8)
- After a modest pullback in early January, U.S. equities regained strong momentum mid-month. The S&P 500 hit an all-time high on January 18 and continued pushing higher afterwards, rising 1.6% in January and resulting in a 15.5% three-month rally. The run was driven by rate-cut expectations, but also strong Tech 4Q23 earnings, resulting in narrow leadership again. Out of 11 sectors, only 5 gained. Tech outperformed with a 3.9% monthly gain, with Communication Services at 4.8%. The Russell 2000 significantly underperformed by falling 3.9%.
(GTMA P. 34, 48)
- Beyond the U.S., emerging markets and Asia Pacific ex-Japan MSCI indices underperformed, with -4.7% and -3.4% returns in January, respectively, dragged down by the disappointing performance in China (MSCI China fell further at -10.6%). In Asia, Japan was a bright spot, returning 4.6% on the MSCI index, buoyed by the BoJ’s continued confidence in inflation and possible move away from negative rates.
(GTMA P. 33, 39)
- With market expectation on the magnitude of rate hikes in 2024 being reduced, bond yields rose in January, with 10-year U.S. Treasury yields rising 7 bps. The short end of the yield curve stayed relatively unchanged, with 2-year U.S. Treasury yields declining 3bps. European bond yields rose. 2-year German bund yields rose 12bps while 10-year bund yields rose 18bps. The BoJ’s hawkish comments led to Japanese government bond (JGB) yields rising. 10-year JGB yields rose by 12bps.
(GTMA P. 23)
- Credit spreads narrowed across the board except for U.S. high yield. U.S. dollar denominated Asia high yield credit spreads narrowed by 71bps, with the asset class returning 2.7% in January. Developed market (DM) government bonds underperformed given the rise in yields, with DM government bonds falling 1.7% during the month. U.S. dollar denominated emerging market debt (USD EMD) fell 1.2% as USD EMD credit spreads widened by 18bps.
(GTMA P. 49, 53)
- The U.S. dollar index consolidated upwards (+1.9%) as bond yields in the U.S. rose from the lows of end-December. The Indonesian rupee was the best performing currency in Asia (+0.2%), while higher beta currencies such as the Korean won and Thai baht declined 3.6% and 3.9%, respectively. The Japanese yen was the weakest currency, falling 4.2%. The Australian dollar also fell 3.7% as industrial commodity prices declined.
(GTMA P. 66)
- Oil prices posted their first gains in four months, with Brent crude up 6.1%. Ongoing geopolitical volatility and blockage of shipping routes has led investors to price in some geopolitical premium. Gold prices moderated, falling 1.1%. Agriculture prices fell again (-1.5%) even as concerns build about the crop production impact from potentially another year of El Niño. Base metals (-2.4%) reversed gains from December amid weak China sentiment.
(GTMA P. 67)