Central banks, geopolitics drive volatility

Rapid risk-reassessment as events unfold

There’s a lot more than just monetary policy for investors to keep an eye on as they try to navigate what direction markets might take from here. Do investors have it right when it comes to central bank policy going forward?

The performance of equity and bond markets continues to be driven by a tug of war between investors and central banks. Many of the former clearly want the U.S. Federal Reserve (Fed) to start lowering interest rates and believed up until a few days ago that it will cut as many as six times in 2024, starting as early as next month. And when that conviction is running high – as it has more days than not over the past few months – stock indexes tend to climb higher, while bond yields usually fall.

But here’s the thing. The Fed has never explicitly said it plans to cut rates that aggressively this year nor does the current economic environment necessarily warrant it. In fact, U.S. Federal Reserve Chairman Jerome Powell recently pushed back on investors who were expecting the Fed to start cutting rates in March by saying that’s “probably not the most likely case” during his press conference following the Fed’s announcement to keep rates unchanged.

In turn, some investors got rattled – sending various stock and bond prices into a temporary tailspin – yet why would the Fed start cutting now? Inflation is still well above the Fed’s 2% target and hasn’t budged much from its current levels in months. Moreover, it’s one thing to anticipate rate cuts in the eye of a recession, but the U.S. economy still seems relatively healthy despite tighter lending conditions. Not only did it grow at an annual rate of 3.3% in the fourth quarter of 2023, but early estimates from the Atlanta Fed forecast an even stronger first quarter of 2024 with growth pegged at 4.2%.

Of course, that doesn’t mean continued economic growth in the U.S. is a foregone conclusion. The effects of tighter monetary policy usually come with a lag and could lead to a seriously weakened economy down the road. But it does mean the Fed has more time to weigh its next move than some investors would like to think it does.

And maybe that’s a good thing given how well stocks have performed of late – thanks largely to solid corporate earnings. Because if rates do end up being cut to the extent that some believe they should this year, then the good that may do for markets could be dampened by the ill effects that are normally associated with a worsening economic backdrop – at least in the near term. While that possibility may be somewhat forgotten at a time when new all-time highs in equities are being reached, it’s something worth reminding ourselves as we progress through the next few months.

Don’t forget geopolitics

In addition to bank policy, geopolitics immediately comes to mind as something that requires our full attention this year. In particular, the escalation of tensions in the Middle East over the past few weeks is increasingly worrisome, though its impact to markets has been relatively benign to date even as it relates to oil prices that have remained surprisingly unchanged by the events that are unfolding.

In addition to the Israel/Hamas War being waged in Gaza – and the Houthi attacks on cargo ships taking place in the Red Sea – the biggest concern is the growing possibility of a direct confrontation between the United States and Iran now that the U.S. military is mounting air and missile strikes against Iranian proxies in Iraq and Syria in retaliation for a drone strike that killed three American soldiers in Jordan late last month.

Of course, all of this is taking place at the same time as the Ukraine War rages on and other geopolitical predicaments like Taiwan’s precarious relationship with China continue to simmer. And then there’s the fact that 2024 is being touted as the biggest election year in history, with more than half the world’s population – four billion people – going to the polls in the next 11 months.

This includes massive elections in countries like India and Indonesia, and perhaps the most important of all from an investor’s perspective, the U.S. presidential election in November, which is shaping up to be a very tight rematch between current U.S. President Joe Biden and his predecessor Donald Trump. Indeed, 180 million Americans may turn out to vote, but the outcome could be decided by fewer than tens of thousands of votes in just a few states. And should the end result be contested by either party – Republican or Democrat – it could significantly alter the policies with which the U.S. deals with the rest of the world.

For example, while it’s unclear exactly what effect the results of the U.S. election could have on markets, my good friend and colleague Greg Valliere noted recently that Trump, in particular, is already stirring the pot by saying he’d fire Fed Chair Jay Powell and raise tariffs on Chinese goods coming into the U.S. to a staggering rate of 60%.

Needless to say, there is going to be a lot more than just monetary policy for investors to keep an eye on as they try to navigate what direction markets might take from here over the course of the next year.

Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd.

Notes and Disclaimer

Commentary and data sourced Bloomberg, Reuters and company reports unless otherwise noted. The commentaries contained herein are provided as a general source of information based on information available as of February 5, 2024, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or reliance on the information contained herein. Investors are expected to obtain professional investment advice.

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.

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