Inflation and interest rates have been present topics. Inflation rates have continuously decreased throughout 2023 across most economies. While this development was promising, it was necessary as inflation rates went as high as almost 12% towards the end of 2022. In the US, inflation has decreased to 3%-4% in the past few months with no particular direction since then. For 2024, it is widely expected that inflation will decrease further, albeit to a limited degree. Most market participants expect inflation to be around 2.3% by the end of 2024. Others see inflation to drop to as low as 1.6%. Assuming no further geopolitical crises and no further escalation of existing crises, inflation is unlikely to rise further than 3.5% by the end of 2024. Figure 1 shows the development of inflation rates in the US, UK, and the EU from January 2022 to the end of 2024. The general sentiment that inflation rates should fall is intuitive given the high interest rates at this time. In the EU, the development has mostly mimicked the US, but with a delay of a couple of months, due to a more restrictive central bank policy when Covid-19 emerged. Inflation in the EU has also reached a point, where inflation is no longer declining at levels slightly below 4% after being at 10% at the beginning of the year. For 2024, inflation is also expected to further fall, but not to the same degree as in the US. Expectations for inflation in the EU range from 2.6% to 4.5% with the most likely level around 3.4%. The situation in the UK also drastically improved towards the end of the year. UK’s inflation fell to 4% after lingering around the 10% mark for almost an entire year. Inflation expectations for the UK are mostly equivalent to the EU’s expectations, but its projections are more volatile based on the country’s state over the past few years.
The month of November has been quite successful for equities and bonds alike. With the stabilizing macroeconomic landscape, markets have adjusted to the current state with high rates and moderate to high, but decreasing, inflation. In the past month, there were promising signs that no more hikes are necessary to combat inflation. A notable percentage of market participants is even optimistic about rate cuts soon. While US inflation has gone down substantially already in summer, European countries are following and are on their way to similar levels as the US. Unsurprisingly, this led to a more positive view on longer-term rates. This was evident in falling yields for longer-term bonds. US and UK 10-year bonds’ yield decreased by around 10% since October, while German 10-year bonds decreased by almost 25%. Figure 1 summarizes the development of 10-year yields from October in the previously mentioned countries.
The conflict between Israel and the Hamas is in full force and it seems unlikely that the situation will be resolved soon. While the conflict started with an attack from Hamas on civilians in Israel, the focus has fully shifted towards Gaza with group, air, and sea retaliation by the Israel military. Israel is strongly focusing on Gaza, as it is seen as the center of the Hamas. The conflict in Gaza is widely seen as a precarious situation, as Israel is completely blocking entry or exit even for vital goods, such as food, water, and medical supplies. While Israel was supported initially by most Western countries (especially due to the many hostages taken), support is continuing to fade, due to the humanitarian crisis it caused in Gaza. Despite the decreasing support, Israel seems determined to not only free all hostages, but also disabling the military and governmental capabilities of the Hamas. Unsurprisingly, the conflict also affected financial markets significantly. While initial price shocks mostly normalized since early October 2023, oil markets could experience further volatility. Additionally, given the already pressured economies, investors move more capital into safe-haven assets, in particular US-Dollar and gold.
The current macroeconomic volatility has not changed. Interest rates and inflation remain elevated. At least in most markets, the inflation rate is continuously declining. In the US, inflation reached 3% and is on its way to the upper target of 2% in the short-term. Europe is following this development but still has a substantial way ahead before inflation will eventually reach those levels, as inflation remains at 6.4%. In the UK, the situation is more dire and inflation declined to 7.9% after being above 10% since August 2022. In order to bring inflation levels down, central banks have hiked substantially over the past 1.5 years. In the US, the federal fund rate is now above 5.25% with the most recent hike, which has largely been deemed unnecessary by market participants. The ECB also increased its interest rate by 25bps and is now at 4.25%. The BoE also raised its core interest rate by 25bps in their latest meeting and is now equivalent to the US’s 5.25%. The US also reached the status of positive real interest rates since the hikes started. Europe and the UK are following this trend but have not reached this territory yet. Figure 1 also shows how Europe and the UK are lacking behind the US. In the current environment, a recession is still likely. While projections have changed throughout the year, the consensus opinion remains that there will likely be a short and with a shallow to medium impact on the economy. The most notable change is that the recession expectation has pushed further and further into the future. It started with estimations that it will happen by mid-2023, then towards the end of 2023. Now, most estimates place the recession somewhen in 2024.
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