December 2023 quarter economic and market commentary
The most prominent development in financial markets during the quarter was the pronounced downward move in US bond yields from the end of October following a sharp sell-off. In large measure that reflected growing optimism that inflation was on a meaningful downward trajectory and that, accordingly, the cyclical tightening of monetary policy was at an end. That optimism was fuelled by the release of projections at the conclusion of the final US Federal Reserve meeting for the year which showed the median “dot plot” for the policy rate at 4.6 per cent by the end of 2024 which implied some 75 basis points (bps) worth of policy rate reductions in 2024. By year-end, financial markets were pricing a substantially greater policy rate reduction of more than 150 bps.
Falling bond yields created significant tailwinds for US equity markets with S&P 500 rallying sharply into year-end.
Falling US yields saw some depreciation of the USD with the AUD noticeably firmer over the course of the quarter. The relative strength of the AUD reflected a further increase in the policy rate in Australia to 4.35 per cent in November. However, by the end of the quarter, local markets were increasingly confident that inflation in Australia was also on a meaningful downward trajectory and that, accordingly, the cyclical monetary tightening in Australia was also at an end.
The key issues for 2024 revolve around whether markets are excessively optimistic in terms of their expectation of policy rate cuts. There is some conjecture that disinflation can be a disjointed process and that the “last mile” for central banks to the inflation target is particularly challenging.
The consensus economic outlook for 2024 is a benign (or ‘goldilocks) one. However, both “stickier inflation or recession loom as non-trivial risks.
Structural factors are shifting (higher “neutral” interest rates, emboldened regulators, growing protectionism, and emergent “mega forces” such as climate, cyber-security and AI).
Geo-political risks are elevated given forthcoming elections and the US Presidential election in particular. Tensions associated with Russia / Ukraine, China /Taiwan, the Middle-East and the Korean Peninsula.
That all suggests that there will be episodic bits of volatility where the potential for seismic shifts in sentiment and the prices of financial assets exist.
