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Global Macro – Emerging Markets 2024 Outlook

Throughout 2023, emerging markets (EM) had to navigate the “triple whammy” of higher US interest rates, a strong US dollar and slower Chinese growth. For most of last year, they weathered this storm with resilience and remarkably even managed to eke out narrow sleeves of outperformance. Heading into 2024, growth across the EM universe is set to stabilise as domestic fundamentals offset external drags, with some rotation from the largest to smaller EMs. Inflation and monetary policy rates are both “over the hump” – disinflation is progressing, and the decline in rates will continue and broaden in 2024. Such dynamics warrant admiration in the face of still restrictive interest rates, fiscal consolidation, tight global financial conditions and slowing developed markets (DM) (see here).

US Fixed Income: Macro Divergences and Curves

Macro View: Lately the US economy has continued to produce strong headline results with most data releases (especially related to employment) but under the surface the data sends a less rosy picture of what is truly happening on the ground. Furthermore, the latest start of the year inflation readings have turned out to be hotter than expected and that has markets concerned that inflation risks have not been addressed fully.

First, we must caution in reading too much into 1-month of data as that does not signal a trend has started. Second, the move to a lower more sustainable inflation backdrop was always fraught with uncertainty and unlikely to be linear (and instead we should expect it to be bumpy). Third, the data trends at the start of the year seem to be suffering from seasonal adjustments that could be over amplifying what is truly happening in the economy. Fourth, when it comes to CPI, a major driver of the move up in January was from the large owner equivalent rent category. Most market-based measures of rent continue to show signs of declining, net we believe that the January CPI is not indicative of a trend to higher core inflation.

Lastly the consumer may not be as resilient as suggested from the first readings post the holiday shopping season. The latest US retail sales was negative on a nominal basis (so sharper in real-terms) and the December retail sales report was also revised lower. It’s possible that there wasn’t as strong of a holiday shopping season and by extension not as many workers hired during that period as well. This could open up the possibility that the US jobs data in the last few months were also inflated too. In the end perhaps the only really inflated is the true state of US jobs.

Fed and US Rates View: Post a string of stronger than expected data and hawkish Fed comments we have moved our official start of the easing cycle from March to May 2024. At this point the first cut could be May or June but we will take it one meeting at a time before we officially change again. In other words, if the Fed skips at both the March and May meeting, we would just move back our starting date to June. In the end we expect 125-150bps in cuts this year. This would take the Fed Funds median range to either 3.875 or 4.125%, which is still more restrictive than the long-run neutral rate of 2.5%. Also given that chair Powell mentioned that the Fed will likely be reviewing its QT policy at the March meeting we now expect an announcement at that meeting regarding QT. They could give a terminal date of when QT will come to an end (via a taper process). We would rather see the Fed reduce the QT to a more manageable level but keep it ongoing to continue to drain the excess liquidity that is in the system. With so much uncertainty ahead, keeping a slower burning QT in the background would still allow the Fed to cut rates later on and watch. Given we have expected a rise in rates (since we viewed the rally in Q4 as too soon and too fast) we only have minor tweaks to our rates path.

FX Outlook

The US dollar has strengthened against most G10 currencies since our last release of the Global Markets Monthly (24^th Jan) with the US jobs report in February the primary catalyst for the gain over that period. The push-back by central bank officials on the extent of easing priced into the markets has been made easier for the Fed relative to other key central banks on the back of the strong jobs data and the higher than expected CPI and PPI readings. We are maintaining our overall view for the dollar going forward – neutral, with a slight bullish bias for an initial period before a clearer USD bearish move takes hold in the second half of the year. Inflation is coming down faster than expected everywhere but weak growth in Europe, Japan and China will help provide moderate support for the dollar. Beyond Q1 into the middle of the year we expect to see some improving economic conditions in Europe after a period of nearly two years of no growth as the bigger inflation shock reverses and helps Europe by relatively more than the US. Growth in the US slows as fiscal support fades and excess savings are depleted fully. Still, high levels of uncertainty globally will keep the scale of dollar depreciation relatively well contained.

KEY RISK FACTORS IN THE MONTH AHEAD

• The main upside risk for USD/JPY would be that this latest phase of stronger US labour market data and inflation persists for longer than expected. That would imply yields staying higher for longer and providing support for the dollar. The MoF could allow for a break in USD/JPY to new highs before intervening which would mean USD/JPY would be higher than expected. If incoming information on ‘shunto’ wage negotiations were disappointing that could also diminish expectations of a rate hike by the BoJ which would further reinforce a move higher in USD/JPY.
• The main upside risk for EUR/USD would be if the US economy and/or labour weakens sharply at the start of 2024 bringing forward rate cut expectation and encouraging a weaker USD. More policy stimulus measures in China could be rolled out in the month ahead. If those measures trigger a significant improvement in the outlook for China’s economy, it could result in EUR/USD rising back above the top of the 1.0500-1.1000 trading range.
• The upside risk for USD/CNY is a lack of further concrete policy initiatives on stabilizing the domestic property market and countering deflationary concerns. The market is waiting for early March’s NPC meeting. CNY could be boosted should a new set of reasonable and optimistic economic targets be delivered.