1 Darkest before the Dawn
Peak growth in this cycle is behind us.
A challenging year for growth
Technical recessions or not, 2024 will be a much more challenging year for growth globally compared with 2023. That economic hardship won't be felt equally across income groups or countries, with the United States more likely to withstand the tightening in the system relative to many other major economies as the country’s domestic focus, strong employment profile, and relative consumer health should all provide support.
"... sometime in 2024, it will be time to think about the beginning of the next cycle."
Conversely, countries that are heavily exposed to international trade and constrained by their ability to borrow are likely to face significant headwinds during the first half of the year, with gradual improvement as central banks begin easing financial conditions. Indeed, 2024 won't feel anything close to the Roaring Twenties thesis that ran rampant from 2021 to 2023. While no cycles are equal, this environment prescribes late-cycle investing strategies, especially in the first half of the year. That said, for many economies, it's often darkest before dawn, and sometime in 2024, it will be time to think about the beginning of the next cycle. Jumping too prematurely on this eventual rebound, however, is dangerous, as troubled waters are still yet to be crossed.
Drivers of successful economies in 2024
- Lower debt sensitivities—Countries with debt profiles (at the government, corporate, and consumer levels) that are either relatively unlevered or that have longer maturity profiles are likely to feel the pain of higher interest rates less acutely.
- More fiscal room—Countries that have the scope to add in government stimulus as a countercyclical measure are likely going to be able to better mitigate the full effect of slowdowns than those that don't.
- Less manufacturing export sensitive—We’re in an environment where key drivers of the business cycle have become desynchronized. Coming out of the pandemic, the focus has shifted from a goods-driven to a services-driven economy, with the manufacturing sector weakening materially. Consequently, economies that are dependent on manufacturing and the export of goods are likely to feel the brunt of a manufacturing slowdown more acutely.
- Exports geared toward essential commodities—While the manufacturing impulse might have slowed materially, supply chain disruptions have left demand for core commodities at high levels. For example, climate and supply chain issues have left key crop prices high and have been a boon to exporters in those commodities.
2 Critical concessions
Central banks reluctantly move past peak rates.
The fight against inflation continues
A material and global disinflation took hold in 2023, but 2024 will likely show that the last leg of the inflation battle is more difficult—not just because year-over-year price growth will struggle to return to the post-global financial crisis/pre-COVID norm, but because central banks will, in our view, ultimately begin easing before inflation definitively returns to target, thereby risking a reacceleration in demand and a possible reemergence of inflationary pressure.
Central banks are faced with an uncomfortable predicament: Do they ease in the face of deteriorating growth despite the likelihood that inflation is still materially above target (and, in price level-terms, sizably higher than pre-COVID)? We expect that, ultimately, they'll either directly or indirectly concede that their blunt tools aren’t the right ones to definitively address the current inflationary environment.
This realization will likely be driven by the very nature of present-day inflation: Central bank tools are designed to cool demand-driven inflationary pressure but are less effective against supply shocks, regardless of whether these shocks are caused by enhanced pandemic-related protocols, climate change, or geopolitical tensions. Certain central bankers have already conceded the point, outlining their constrained ability to countermand external shocks.
"The Bank of Canada cannot control global commodity prices. That is why we are focused on a broader range of indicators, in particular our measures of core inflation that strip out the volatile components of inflation."
Tiff Macklem, Governor of the Bank of Canada
The consequence of this dynamic is that provided inflationary pressures aren’t an acute point of concern, policymakers are likely to relent in the face of weaker growth and choose to reduce restrictive policies in order to counterbalance a softening economy.
This trend will be especially true for central banks with dual mandates, such as in the United States or New Zealand, or in economies that, because of high amounts of leverage, are particularly sensitive to higher rates: Canada, with its levered consumer and expensive home prices, would be one such example.
Global rates are expected to fall in 2024
However, it's important to note that there's a difference between normalizing policy toward more neutral levels (which would imply that monetary policy is neither restrictive nor stimulative) and switching to easing mode (which would create an environment in which low interest rates actually stimulated the economy). In this environment, we view this latter development as unlikely, especially with inflation still running above most central banks’ target.
Within this context, in which the limits of central bank policy become evident, we expect a growing dialogue around new nontraditional central banking tools such as central bank digital currencies and the use of targeted tools, such as those available during times of financial system stress. We also anticipate more focus on core central banking assumptions—from the appropriate neutral rate of respective economies to the concept of a 2% inflation target, which is used in many developed-market economies.
Key questions confronting central banks this year
Is 2% the right target?
As economies slow at a faster pace than inflation normalizes, the pressure to ease current monetary policy stances will intensify. If the last leg down in inflation back toward traditional targets proves difficult to achieve, a growing chorus of voices could potentially call for lowering the bar to cuts by raising the inflation target.
The post-COVID economy looks different: have we moved to a persistently higher interest-rate environment?
We suspect the answer to this question is yes although, admittedly, the bar to being in a higher-rate environment is extremely low, given that central banks kept policy rates at essentially zero for the better part of a decade, which we wouldn't expect to see again for some time, barring an acute crisis.
Are quantitative easing and tightening things of the past?
We doubt it. Quantitative tightening is still ongoing in many economies, including the United States. We tend to think of policies like this as akin to putting more tools in the toolbox, to be used as the situation warrants. That said, just because they’re available doesn’t mean they'd need to be used.
3 The big shift
From a demand-driven to a supply-driven world.
The drivers of our global economies (and the market implications of such) are moving away from traditional demand-side factors and toward the supply-side influences of the world: Because of the shifting geopolitical environment, globalization has been replaced with friendshoring/onshoring, climate events have translated into supply chain disruptions for key commodities, and postpandemic policies have resulted in meaningful delays across supply chains. While the supply-side driver conversation has focused on inflation for much of the post-COVID period, it's bleeding across a wide range of core economic narratives, including labor markets and productivity, and will continue to do so in 2024 and beyond. We don’t necessarily view a more supply-dominant world as a one-way trade (although it's certainly structurally supportive of real assets), but rather that the relative importance of many indicators, economies, and politics will shift. Importantly, this will require careful assessment of traditional forecasting tools. It will also likely open up new investment opportunities: On a regional basis, any friendshoring/onshoring efforts that would occur from strategic supply chain realignments could prove interesting, as could thematic investments that are more closely tied to strategic government priorities, such as green investment or defense spending.
Data that needs more focus in a supply-driven world
- Labor shortages—An aging workforce could continue to affect employment dynamics in two ways: First, as the 55+ cohort approaches retirement, the pool of available labor is affected. Second, the departure of more experienced workers could leave institutions with knowledge gaps.
- Artificial intelligence—Expanded use of artificial intelligence (AI) could potentially lead to a productivity miracle similar to what was seen during the earlier days of the internet, where seemingly above-trend growth and modest inflationary pressure combine.
- The weather—An increasingly important part of supply chain disruptions and corresponding price shocks are climate events.
Asset classes that could receive more investor attention
- Strategic commodities—Raw materials that are either nondiscretionary (e.g., agricultural assets) or strategically important will be an area of focus.
- Fixed income—Our base case is that while central banks ease, they won't lower policy rates to the point where they’re stimulative to the economy. This is at least partly because of incremental modest inflationary pressures caused by the realignment of supply chains. Consequently, with higher base-level yields, the return profile around fixed income is likely to be fundamentally different relative to other asset classes than it was in a zero-rate world.
- Relative beneficiaries of supply chain realignments—With onshoring and friendshoring becoming more pervasive structural factors in supply chains, countries that are deemed more secure are likely to benefit from continued foreign investment. Similarly, companies responsible for supporting onshoring initiatives are likely to benefit.
4 Out of sync
Desynchronization expands and accelerates.
While global desynchronization is now a well-understood macro theme, it often gets specifically viewed through the lens of U.S.-China economic decoupling or other measures of broad deglobalization forces. In 2024, we see these elements of global desynchronization accelerating but also expect to see other areas of uncoupling. For one, the global economy is still distorted by the COVID shock and the global manufacturing and services sectors are uncharacteristically disconnected: Manufacturing has experienced a period of negative growth; it’s already evident in export-centric countries such as Germany, which is already teetering on the edge of a recession. Conversely, while demand for services is moderating, it still remains relatively healthy; Spain is a good example. That’s problematic for forecasting models, but it may also present opportunities even as some areas of the global economy falter. We also expect that growth challenges in 2024 won't be distributed equally across economies or income groups, once again muddying the idea of a single, simple global economic forecast applicable to all. In 2024, we also expect to see more focus on intraregional stories. In addition to dynamics such as the European example above, the same general dynamics can be applied to the emerging markets: Certain countries are likely to feel the full impact of Mainland China’s structural slowdown and/or U.S. growth challenges differently.
Better understood areas of desynchronized growth
- The divergence between goods and services—The manufacturing sector has already experienced a slowdown as a shift from goods to services has occurred. This is in part due to a shift away from using discretionary income on items back toward services such as vacations and dining out.
- Timing around exiting lockdowns—Countries that took longer to emerge from restrictive lockdowns are still, to varying degrees, enjoying that postopening surge, while regions that exited earlier are closer to normalizing. For example, even though it ultimately proved short-lived, Mainland China’s exit from lockdown conditions was the impetus for a short-term risk-on rally late in 2022 and in early 2023.
Less well-recognized areas of desynchronized growth
- Long(er) and more variable lags—Market participants understand and expect that the global monetary policy tightening experienced in 2022 and 2023 should lead to a lower growth environment. What’s less clear is how quickly the full impact of those moves will be felt.
- Labor market dynamics—Because of recent employer trauma around scarcity of labor, it’s possible that companies will go to greater lengths to retain workers even against a backdrop of slowing growth, which could in turn support the economy and extend the cycle.
- What happens when policy eases? Several themes that dominated 2023, including cash as an asset class and the bifurcation between U.S. new and existing home sales, were due to high policy rates. As central banks ease, the opportunity cost of certain decisions (refinancing a mortgage, flows into money market funds) will diminish, possibly reversing certain trends.
5 Fiscal dominance
Governments grow and become more disruptive.
The COVID pandemic and, more recently, the rise in global defense spending unlocked a surge in fiscal stimulus, some of which was likely necessary and net positive and some of which was likely excessive and inflationary. In 2024, we expect the growing government share of spending in both individual countries and the world to become more prominent and structural. It will likely show more tangible impacts, including the disruptive nature of a significant increase in sovereign bond supply and the rising costs of large sovereign debt overhangs. Several major elections will become focal market events, decreasing visibility around key policy initiatives and increasing volatility: The Netherlands has recently undergone one such election, and the U.S. election in November 2024 is also likely to require a lot of attention. More strategically, countries with more fiscal room to support their economies through weak economic times will be advantaged, although how that government spending is dispensed (e.g., green spending versus defense spending versus direct redistribution spending) will matter.
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