This could be described as the first full year since 2020 that the Covid-19 pandemic has not dominated the headlines and been at the forefront of economists’ minds. Other concerns, such as the return of high interest rates, volatile energy supplies and geopolitical conflict have taken precedence.
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The strength of the US economy has certainly been front of mind for many, as it continually surprised to the upside and defied analysts’ expectations for a recession. Latin America has also been strong with its two bellwether economies, Brazil and Mexico, putting in robust performances.
Yet other parts of the global economy have not fared so well, with a mixed picture in Asia as China found itself having a difficult time. All of this has given rise to a degree of uncertainty going into 2024, with many asking whether things will improve. The consensus is that while the global economy will remain choppy and growth will be weak the world over, it will keep ticking along in a way that surprises market watchers.
Uncertainties remain, with analysts highlighting energy and geopolitics as two areas that could upset any move towards calmer markets. Both are shaping the world in different ways.
European energy issues
One point of separation between the US and eurozone has been the root of inflationary pressures this year. In the US, the price hikes have come from domestic drivers such as more expensive consumer goods and services.
By contrast, the eurozone has seen pressures come from external factors such as energy. Some believe the worst of the inflation crisis is over in Europe as energy prices have stabilised and should continue to head downwards in 2024. Still, there is potential for them to spike again given the current Israel/Palestine conflict. Many are concerned that this could escalate into a broader regional war. Such risks are difficult to quantify, but a spike in the oil price is a realistic scenario should this happen, which would be detrimental to Europe.
However, BNP Paribas’s economist for Europe, Gerardo Martinez, remains upbeat that inflation can be tamed in the bloc. “We see inflation returning to target in the eurozone in 2025,” he says. “That assumes monetary policy is effective, with energy risks, alongside geopolitical risks, being contained. That is our baseline scenario, but we highlight the risks are elevated and skewed to the upside.”
Central bank strategy
The US is in a more fortunate position as its energy independence gives the Federal Reserve less to worry about on that front. Energy is not a big source of price hikes in the country.
“We expect that there will be rate cuts in the US and eurozone in the second half of 2024,” says BNP Paribas’s global head of macro strategy, Sam Lynton-Brown. “The bar for further rate hikes is very high – for example, tightening financial conditions will allow the Fed to be less hawkish on interest rates.”
Other experts, such as HSBC’s chief multi-asset strategist Max Kettner, do not foresee oil prices skyrocketing.
“I would not be a proponent of oil going to $100 or $150 a barrel,” he says. “You can see how the supply coming out from the US has increased a little and there is this deal [an easing of sanctions] with Venezuela.
“We would have to see Russian and Iranian output be completely cut for prices to spike very high. Currently, Iran supplies about 700,000 barrels a day and that would have to be severed totally for anything to happen. The price is pretty range-bound and I would call a sharp price hike a low probability tail risk.”
Even so, Mr Kettner argues the combination of pessimism combined with several economies surprising to the upside — including notably the US — makes policy difficult for central bankers.
“It is hard to work out the implications of this current trend,” he says, referring to bearish forecasting but with growth to the upside. “Does it mean central banks will hold rates or cut rates later? Also, what does it mean for quantitative easing?”
Mr Kettner points out that over past 25 years, investors have been accustomed to a risk-on/risk-off-world. In its outlook for 2024, published in October, HSBC says that the return to this will only happen once global growth genuinely surprises to the downside and recession fears take over from interest rate and inflation concerns.
HSBC currently sees the market moving between two poles. When real yields drop and break-evens rise — this is what is termed a ‘Goldilocks’ environment — carry assets and growth in equities outperforms, and the US dollar weakens the most.
In contrast, ‘reverse Goldilocks’ is when virtually all asset classes drop in value, with the dollar and cash remaining the only safe-havens.
For the Goldilocks scenario, HSBC says that investors should look at growth equities, carry assets and consider underweight cash. In the reverse scenario, it is better to have an overweight cash position.
Heading into 2024, the bank remains overweight global equities and high-yield credit, and slightly overweight cash, while underweight developed market sovereigns and investment-grade credit.
Asia’s pressure points
According to an October note from Nomura, higher oil prices are expected to worsen current account balances across Asia. However, the exact effect will be hard to gauge due to price controls and government subsidy regimes across the region.
Its research suggests that raised oil prices are likely to have a larger impact on inflation in the Philippines and create more fiscal pressure in India, Thailand and Indonesia. Nomura also sees minimal impact of higher oil prices on China’s fiscal finances.
Another source of inflation pressure over the next few quarters is food. In a different note Nomura points out two factors – El Niño and food protectionism – which could make the cost of staples rise.
It says that El Niño is expected to strengthen as the year progresses, which could impact crop output in 2024. This could be compounded by India’s export ban on all rice varieties, meaning that these bans could be expanded to cover other products.
Nomura’s research adds that rice prices have increased in Asia, leading to spillover effects in emerging economies, such as the Philippines. Still the good news for the Asia-Pacific region is that various other measures of core inflation are coming down, even as food prices rise.
Latin American outlook
In a research note, Fitch Ratings projects regional growth of 2.1% for Latin America in 2023. This is down from 3.8% in 2022, despite strong performances from its two largest economies: Brazil and Mexico.
However, growth has been mixed elsewhere in the region. There has been expansion in Central America underpinned by remittances, but weakness emerging in the Andean nations and a drought-induced recession in Argentina.
Looking back over the year, Société Générale chief economist Klaus Baader says: “One thing that is also worth noting is perhaps the region with the greatest upside surprises in 2023 has been Latin America. It is all the more interesting and intriguing because central banks [there] have been more radical in terms of tackling inflation.
“They have extraordinarily high policy rates — see Mexico and Brazil. The economies there have done exceptionally well [and] will grow well next year too.” Recently, Banco de México held its interest rate at the all-time high of 11.25%, while Banco Central do Brasil reduced its rate to 12.25%.
Fitch Ratings also forecasts growth for Brazil and Mexico, but at a slower pace in 2024.
Africa’s economic powerhouses
Egypt and Nigeria, the two largest economies in Africa, are widely seen as having great potential, but are unlikely to meet it due to adverse economic conditions. According to BMI, a Fitch Solutions company, Egypt will continue to face numerous structural obstacles.
One such obstacle is the dominance of the country’s state economy, especially those parts close to the military, which limit the private sector, as well as Egypt’s proximity to the conflict in the Gaza Strip. BMI estimates that real gross domestic product (GDP) growth will average 4% year-on-year from 2024 to 2032, compared to 3.8% in the 2010–2019 period, on the back of expanding private consumption, strong tourism activity and rising direct investment.
Nigeria also faces security problems, such as recurrent Boko Haram attacks combined with instability in neighbouring Niger.
A collapse in oil prices could also weaken the country’s current account position, while El Niño could disrupt agriculture heading into 2024. Nigerian president Bola Tinubu’s flagship policy reforms of removing fuel subsidies and the devaluation of the naira have also run into difficulties since they were introduced — both markedly pushed up inflation. On the positive side, BMI sees the Nigerian economy expanding by 2.9% due to moderating inflation and favourable trade environment.
The third big economy, South Africa, is expected to see its real GDP growth accelerate to 1.9% in 2024, compared to 0.5% in 2023. However, government spending continues to outpace revenue and higher debt servicing costs will crowd out money for public services. One factor that should influence the budget next February is the election expected in May 2024. Its timing is likely to discourage sharp cuts to government spending unpopular with the electorate.
More broadly, Capital Economics says that Africa’s recovery from the Covid-19 pandemic has been the slowest in the emerging world, but the GDP data shows that most countries have turned a corner. Inflation has also started to decline and that has provided some relief for households.
Capital Economics Africa economist, David Omojomolo, says a big distinction between economies in Africa lies between the countries with debt in their own currency and those with debt in foreign currency.
“Even if [South Africa and Nigeria] have a sizeable amount of debt, it is in their own currencies,” he notes. “But countries such as Ghana and Zambia can be hit with sudden spikes in international borrowing costs as they hold debt in foreign currency.
“The other factor to consider is China, where it is weighing down metal exporters like Mozambique. So, in terms of the external conditions going into 2024, there is quite a lot of divergence for a number of African economies.”
Middle Eastern diversification
The two largest economies in the Middle East, Saudi Arabia and the UAE, are both attempting to diversify their economies. In Saudi Arabia, above-trend oil prices will help underpin some of its non-oil economy, according to BMI. However, this will not generate enough private sector jobs in areas that the country wants to expand, such as tourism, entertainment, sport and high-end technology.
The BMI also expects robust spending by the Public Investment Fund and other government-related entities, especially the National Development Fund, to help Saudi Arabia meet its Vision 2030 programme objectives of a thriving economy.
This spending will support Riyadh’s strategy in three main areas: financing large infrastructure projects, job creation outside the oil economy and keeping public finances in check.
Meanwhile, the UAE’s growth is expected to hit 4% in 2024, up from 2.6% in 2023. Key opportunities include diversification into tourism, financial services and high-tech industries. These could be a hedge against volatile oil prices. However, it also faces several threats, including an escalation of tensions with Iran and attacks from the Yemen-based Houthi rebel group.
Debt capital markets
According to Lloyds Bank’s capital markets head of bond syndicate, Keval Shah, the big thing this year has been how economies have surprised to the upside.
“We have been in a weird place,” he recalls. “Everything feels more expensive, but people are still carrying on [with economic activity]. The consumer data is not showing a recession [in the UK]; there has been a lot of adaptation and resilience that has developed.”
Mr Shah estimates that next year many corporates will do more refinancing, and aim to get it done before elections in the US. Higher interest rates are also the driving force behind a lot of shifts in behaviour. One on the one hand they are positive for companies that want to offload pension liabilities to a life insurer. This should, in theory, free up resources for research and development or hiring.
Yet the transition to higher rates has been more painful for businesses that are highly leveraged. Mr Shah predicts less activity here, and adds: “The other part of the market that is very unclear is the sub-investment grade. We are going to see far less private equity (PE) leverage led deals.
“There are also areas of the economy that need refinancing, such as the auto sector, utilities and infrastructure. The UK water sector has some work to do. The utility question is a pan-European one and affects countries like Germany that got rid of nuclear power.”
Another area that is unclear is cross-border mergers and acquisitions, which Mr Shah believes “will happen somewhere” in 2024.
There will also generally be a lot of funding that will be done in capital markets, rather than through direct lending from banks. Undoubtedly, the unwinding of quantitative easing by central banks will also continue.
And while there might be days when markets are volatile and people cannot trade, the system still has enough liquidity in it for activity to carry on.
ECM resurgence
The market for initial public offerings was very quiet in 2023, compared to the high level of activity in 2021. During a UBS webinar in November that assessed the year ahead, analysts said there has been a small but noticeable jump in activity in the past quarter, which many hope will be maintained in 2024.
There are several reasons underpinning this more buoyant outlook. During the webinar, Gareth McCartney, global co-head of equity capital markets (ECM) at UBS, said: “We anticipate a better year for ECM volumes in 2024, after we have seen a generational repricing of interest rates.
“The theme of de-globalisation with the impact on supply chains and the decarbonisation story have challenged investors. The fundamental question is: How do you adapt to a higher interest rate environment?
According to Mr McCartney, there are a number of factors that will support underlying issuance volumes in 2024. “There are still high levels of cash in the system; PE is sitting on many assets where public markets will be a natural home for them and the worst of the interest rate hike is over.
“Many of the macro headwinds are behind us and we have an election cycle ahead. We expect that in the coming window, corporates will refinance through primary equity listing and not debt,” he added.
The generational repricing of interest rates that Mr McCartney described will be felt the most in the PE sector, where a profound change is underway.
During the webinar, Simona Maellare, global co-head of the alternative capital group at UBS, said: “[This year] has been a tough year for PE deals, activity has been down around 60%. We have seen a shift to mid-market deals. They offer a more straightforward path to value. So, there has been a radical change and the PE sector is back to investing in the old-fashioned way.”
With so much change in the world economy, investment bankers, central banks governors and other market players will have to stay alert to navigate any obstacles that come their way. There will be opportunities to make money, but the path of interest rates, energy prices and geopolitics could all be significant sources of stress.
