2024 begins with a lot of optimism and a lot of uncertainty – 12/27/2023 – Solange Srour

At the end of the year, the markets had an extraordinary performance. Since the beginning of November, the S&P has risen almost 14%, interest rates on US 10-year Treasury bonds have fallen from around 5% to less than 3.9%, the Brazilian stock market has risen around 17% and the real has appreciated up around 4% against the dollar.

Lower inflation data in the US, activity indicators that corroborate the economy’s soft landing thesis and the Fed’s signaling that we could see up to three interest cuts in 2024 support positive bets. But what will be the reality next year? Have we eliminated the risk of recession there? Will we reach the level of inflation and low interest rates that the markets project?

There is no doubt that the latest data is favorable, but it is still far from consolidating such optimism. The pandemic and economic policy responses have made it very difficult to predict how the U.S. and global economy will evolve based on traditional models. Jobs, wages and other key metrics are refusing to follow historical trends in many places.

The resilience of US economic data to the rise of around 500 bp in interest rates, starting in March 2022, could frustrate current market projections regarding the magnitude and speed of the cuts: around 150 bp starting in March of the year next. The Bloomberg index of financial conditions is at its loosest level in nearly two years — a considerable boost to the economy long before the Fed actually begins cutting interest rates.

The enormous budget spending that began in 2020 sustained demand for a long time, even when signs that inflation would not be temporary were evident and the Fed was already raising interest rates. Savings accumulated by families – a variable that is difficult to measure – played a relevant role in sustaining consumption. Today, it has already retreated significantly, and the impacts of fiscal policy are gradually receding. On the other hand, the job market, although showing signs of slowing down, remains strong, supporting income and cushioning the effect of the fall in fiscal stimulus.

Another surprise was the resistance of one of the sectors most sensitive to interest rates: real estate. Interest rates are now much higher than they were several decades ago, but we have not seen a significant slowdown in property prices that could impact wealth and consumption.

The fact is that many borrowers locked in low-rate financing before inflation and interest rates rose. There will be refinancings over time, which means we should see a slower decline in prices going forward rather than a single big event.

The same went for companies. We saw massive corporate defaults this year, but we didn’t have the “tsunami” that was predicted. However, even though it is low relative to other interest rate hike cycles, after a decade of declines, the number of U.S. business bankruptcies increased by 30% in the 12 months to September compared with the same period a year ago, according to with data from American courts. Whether this process will be gradual or not will depend on whether the long interest rate continues at today’s lowest levels.

Another uncertainty results from an increasingly polarized world. In addition to experiencing two wars, the possibility of more trade and tariff tensions next year is extremely high.

We will begin 2024 with elections in Taiwan, which could further impact relations between the US and China. The US presidential elections will be held in November, and until then a lot of volatility is expected.

What seems certain is that we will increasingly have greater subsidies for clean technology, energy independence and the search for more diversified supply chains. The fragmentation of the world, in addition to the inflationary context in the medium term, will affect the pricing of risk in the markets and financial flows.

And what are the consequences of so much uncertainty for Brazil? The Central Bank, rightly, has been cautious, signaling the continuation of the monetary easing process at a rate of 50 bp per meeting in order to maintain monetary policy in restrictive territory and ensure the convergence of inflation.

In the fiscal field, the deterioration in the credibility of the fiscal framework has not affected asset prices, given the euphoric external scenario. Whether it will be sustained or not will depend on American data and the Fed’s response. As usual, we are hanging on to the direction of the external scenario.

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