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Risk assets ended 2023 on an upbeat note as the Fed appeared to make a big bet on inflation coming down and growth only gradually slowing. Markets interpreted the Fed’s messaging as a green light for aggressive policy easing. The end-2023 rally could keep going well into 2024 as inflation cools further. Yet the jittery start to 2024 for stocks and bonds suggests investors may be nervous about the macro outlook. We stay nimble and think macro risks need to be deliberately managed.
The U.S. 10-year Treasury yield closed the year roughly where it started – at about 3.8% – masking a major round trip between 3.3% and 5%. U.S. stocks ended 2023 just below their all-time high largely thanks to the Fed unexpectedly making a big bet for the market by seeming to endorse expectations for aggressive rate cuts at its last policy meeting of the year. That once again highlighted how hopes and disappointments about the Fed drove market flip-flops throughout 2023.
The final rally was no different, in our view. It has left equity markets priced for a near-perfect outcome: a soft landing, where inflation falls and central banks sharply cut rates. Market pricing implies they would come to the rescue with even bigger rate cuts if growth risks emerge. That’s why we think expected bond volatility remains high (yellow line in chart) relative to subdued expected volatility in stocks (orange line).
Markets interpreted the Fed’s communications around a potential peak in U.S. interest rates as opening the door to sharp rate cuts as inflation falls. We expect inflation to ease close to 2% in 2024 as consumer spending normalizes from the pandemic and goods prices fall. So beyond the early January jitters, the risk rally could extend – until the risk of inflation resurging comes into view later this year, as we expect.
Markets pricing in a perfect outcome is a big macro bet, in our view. A soft economic landing is possible, but the range of potential outcomes is wide in the new regime of greater macro and market volatility. That’s why we’re ready to be nimble and selective on our six-to-12-month tactical horizon.
Case in point: Falling U.S. goods prices are dragging down inflation as pandemic-driven swings in spending unwind. Yet a tight labor market is driving stubbornly high wage growth, as seen in the December jobs data. We think that means inflation is set to rollercoaster back up near 3% in 2025 as the goods price drag fades.
We see geopolitical fragmentation bolstering inflationary pressures in coming years, too. That’s why we think the Fed may not be able to deliver the rate cuts markets expect, even with growth moderating as consumers exhaust their pandemic savings and government spending on defense and student loan forgiveness tapers off. The big question for risk assets: when they might start to reflect this outlook in 2024.
In fixed-income markets, we see more volatility ahead partly as inflation’s persistence becomes clearer. Plus, we see markets grappling with where neutral rates – the interest rate that neither stimulates nor restricts economic activity – are settling after the pandemic. We think neutral rates are higher in both the U.S. and Europe, partly due to looser fiscal policy and the investment demands tied to the low-carbon transition. We also think investors could demand more compensation for the risk of owning long-term bonds given rising public debt and a more uncertain inflation outlook.
We get granular to navigate macro uncertainty, favoring Japan, tech and industrials in stocks. We also went tactically neutral long-term Treasuries in October and we keep our overweight to short-term Treasuries. Yields may swing in either direction as markets keep reassessing the outlook for policy rates.
Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.
Alex Brazier is Managing Director, Deputy Head of the Blackrock Investment Institute at BlackRock Inc.
Wei Li, Global Chief Investment Strategist – BlackRock Investment Institute, and Tara Iyer, Chief U.S. Macro Strategist – BlackRock Investment Institute, contributed to this article.
Disclaimer
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
© 2024 BlackRock Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. This article first appeared January 8, 2024, on the BlackRock website. Used with permission.
Image: iStock.com/Rod Hill
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