Michael Savage: Financial markets have many other concerns beyond inflation

After a global pandemic, wars, double digit inflation, and rate hikes that far exceeded expectations, investors are hoping for more certainty and stability. However, 2024 may disappoint

Markets are watching closely: A divisive and destabilising 2024 US presidential election race would not help.

Financial markets have all but priced in an end to one of the most aggressive rate-hiking cycles by central banks across advanced economics in the last 40 years. Having been almost exclusively focused on the path of inflation, a broader range of questions are now dominating markets in 2024.

The most immediate question facing investors is how high and for how long the major central banks will hold interest rates. The “higher for longer” mantra drove rates to new highs, and markets are now expecting a pivot from the US Federal Reserve, the European Central Bank, and the Bank of England, with easing of monetary policy expected in 2024. The central banks themselves appear less convinced. 

In currency markets, the dollar benefitted from the Fed’s aggressive hiking cycle that started in March 2022, with the US currency reaching parity with the euro in late 2022 before easing back slightly in 2023. The key question here is, if rates have indeed peaked, has dollar strength also peaked? Markets are currently anticipating that both the Fed and the ECB will ease rates in 2024. All else being equal, that would imply a relatively range-bound year for the currency pair. However, any US-centric shock along the lines of the March regional banking crisis would likely weaken the dollar, while a recession in the eurozone along with a a strengthening US economy may see the dollar revisit its highs of 2022. 

Many investors are convinced that geopolitical uncertainty will be a key driver of financial markets. The inflationary impact of the Russian invasion of Ukraine became all too apparent in the last two years, with interest rates soaring higher. In commodities, valuations of energy and agricultural commodities, including Brent crude oil, natural gas,  and wheat hit new highs largely due to supply shocks and market fears. With geopolitical risks growing globally, escalations of tensions in Ukraine, the Middle East, Taiwan or elsewhere are sure to add to growing risk premiums for commodities. 

Advanced economies, out of necessity, are transitioning to lower carbon energy sources and technologies. The global supply of commodities currently required to achieve such a transition simply isn’t sufficient to meet expected demand. According to a recent UBS report, cumulative demand to 2050 for zinc, nickel, cobalt and copper would use more than 100% of the known reserves. Even the prices of fossil fuels can rally in the face of the green transition. Green energy supply needs to be incentivised and that is unlikely to happen without much higher oil prices. 

Another important question for financial markets in 2024 relates to the sustainability of public debt. US federal debt levels are expected to approach 115% of GDP in the coming decade. High debt levels, along with entrenched deficits, exerted upward pressures on US Treasury yields in 2023, even as inflation worries subsided. 

In Europe, there are similar concerns. Financial markets got an extreme test case in late 2022, when former UK prime minister Liz Truss and her chancellor Kwasi Kwarteng delivered an ill-fated mini budget. 

What the tipping point is in the US or EU remains to be seen, but Fitch Ratings has become the second of the three major credit rating firms to remove the coveted triple-A grade from US government debt. Markets are watching closely and a divisive and destabilising 2024 US presidential election race would not help in this regard.

Equity markets outperformed many analysts’ expectations in 2023, with the performance driven almost exclusively by the “Magnificent 7”, which include Amazon, Google, and Apple. The weaker performance of the remaining 493 members of the S&P 500 may be indicative of an underlying weakness in the US economy. The question for investors is whether the Magnificent 7 can keep delivering. 

Financial markets do not like uncertainty. But having gone through record levels of volatility that included a global pandemic, wars, double digit inflation, and hikes by central banks that far exceeded expectations, investors are hoping for more certainty and stability. However, 2024 may disappoint. Weaker economies that threaten recession, geopolitical risks, an uncertain inflationary outlook and growing public debt are a cocktail that may result in more unexpected turns in markets in 2024.

• Michael Savage is head of interest rate flow at Bank of Ireland Corporate and Commercial Banking