International & Macroeconomic Trends: 2023 – 2024

International & Macroeconomic Trends:  2023 – 2024

The 2023-24 time period is moving the world into a different construct from the pre-COVID, pre-Ukraine environment.  International relationships have been altered and business and economic alliances are changing.  The Russian invasion of Ukraine has strengthened the relationship of the NATO countries, which are in the process of expanding its participants (i.e., Sweden and Finland).  Ukraine has applied for membership.  Bosnia, Herzegovina, Georgia, and Kosovo also aspire to membership.

Russia’s weaponization of its energy flow to Europe, more specifically impacting Germany, has severely undermined that relationship, maybe permanently.  The failure of the Russian military, depleted material and weapons, and growing unrest in the home country, does little to encourage its supporters in China and Iran.

China continues to struggle with its COVID policies.  The periodic lockdowns continue to disrupt economic activity, lending some forecasters to suggest a slight decline in Q4 GDP.  Worker protests have been growing and the property market continues to be under pressure.  Public policy measures are being proposed to stimulate activity.  Reserve requirements have been lowered (making more funds available for lending), thus supporting that market.  Time will tell whether the measures will work.

The instability of the supply chain from China is only accelerating the move to outsource elsewhere and bring more manufacturing facilities to the US.  Intel and Apple are recent examples.

The infrastructure bill and the recent federal legislation that supports the chip industry are catalysts for creating a new domestically based supply chain.  This cycle could easily be ten-years.

The alternative energy segment provides additional stimulus to developing liquefied natural gas, solar, etc.  Fossil fuels remain an important component for meeting our energy needs for the long-term transition.

Current technology trends and future development will continue to have a profound impact on everyday life and business decisions.  Artificial intelligence, cloud computing, advanced connectivity—topics that our Chief Investment Officer Patrick Snell, CFA has discussed for some time—are permeating practically every business.  These include biopharma, aerospace and defense, manufacturing, and virtually every aspect of consumer life.  The next wave of change, which was discussed in the November 28th Barron’s, is quantum computing, another leap forward. There will no doubt be other developments that will surprise us.

Central banks around the world will be faced with a different set of problems, from inflation fighting to growth and employment initiatives.  Europe is already feeling recessionary conditions from both monetary policy and energy supply disruptions. The lagged effect of higher interest rates and the unreliability of the energy supply is likely to plague the economic landscape for several years.

The Federal Reserve, specifically, will be faced with conflicting pressures.  These include inflation, recession (employment), crypto crisis, currency pressures, and externalities such as food, energy, world conflicts, climate change, and the emergence of political pressure. Despite the rhetoric, change is underway at the Fed.  The FOMC statements and minutes indicate a recognition of the lagged effects, thus a revisiting of the 2019 approach.  What is not being said is that the staff of economists at the central bank are updating and revising their forecasting models, which will generate different scenarios for the FOMC to consider.

Another important aspect of monetary policy is the changing of the guard at the FOMC in February 2023.  Three hawkish members of the committee—Bullard, Mester, and George—will attend one last meeting on December 14th as voting members.  At the February 1 meeting, three new voting members will join.  They are less hawkish, or have a slightly dovish bias.  Consequently, the meetings are likely to become less harmonious.

Focusing on the near-term environment, recent data does little to provide clarity.  Despite what appears to be a strong nonfarm payroll employment report for the month of November, the 2023 to 2024 landscape is likely to be quite different from what the Fed is currently forecasting.  The household survey provides a different picture.  The labor force fell again, and the participation rate, the average work week, and overtime all declined.  Some forecasters estimate that the 0.3% decline in the work week is equal to the loss of 200,000 to 380,000 jobs. Also, The Wall Street Journal reported that the payroll figures may be overstating the strength of the job market by as much as 500,000 jobs based on the more comprehensive figures provided by employer tax records.  In time, these adjustments will be made in the data.  However, given the current situation and Powell’s comments, a 50 basis point increase in the federal funds rates to 4.0 to 4.5% at the December 14th meeting is likely. This increase and the lagged effects of the previous unprecedented increases will continue to weigh on economic activity.  Also, money supply (M1) has now failed to increase over the last 12 months (October 2021 to October 2022), which is a very restrictive policy, standing in stark contrast to the 50% increased experience during the pandemic.

The Fed’s aggressively restrictive policy is being felt throughout the economy and is evident in many leading indicators.  Housing is showing further signs of weakness and home prices have declined for 3 months in a row.  The ISM survey, a forward-looking indicator, points to contraction in manufacturing and less inflationary pressures.

The years 2023 to 2024 are likely to stand in stark contrast to 2021 to 2022.  The secular trends are likely to continue to play out while the cyclical factors should fall victim to the very restrictive credit environment, as well as international constraints.  Currency derivatives add to the risk of financial instability.

The equity market continues to wrestle with the cross currents of growth versus recession and the Fed’s response.  It is interesting to note that the 10-year treasury remains well below its 4.25 high, sitting at 3.5 to 3.75% and responding very little to indicators of growth.  Also, the yield curve remains steeply inverted.  These factors appear to be placing a floor under the equity market which faces heavy negative sentiment, a contrary indicator, and huge cash positions on the sidelines.  The lows reached on October 13th still appear to be intact (yet barely, in NASDAQ’s case).  In our judgment, the changing of the guard at the Fed in 2023, the weight of the very restrictive policy on economic the activity, and the growing currency concerns, will change the rate forecasts for next year and place the Fed in a more benign position.  Such a posture would be a positive for the financial markets.