We cover these macro issues (and more) as we look at what's in store for markets in 2024.

1. Will there be recession or a soft landing in the US?

The US economy exceeded almost all expectations this year, delivering robust growth, alongside an impressive moderation in inflation (Chart 1).

Source: Haver, abrdn, December 2023.

This has further increased the probability of a soft landing, but the economy will face several headwinds entering 2024. Household saving stockpiles are likely to become exhausted, the strain of higher interest rates will weigh on consumers and corporates as they refinance debt, credit conditions remain extremely tight, and a supportive fiscal backdrop in 2023 will shift to a small drag as spending cuts bite.

We believe these dynamics will most likely push growth below trend over the first half of 2024, before a mild recession in the second half. Indeed, the Sahm rule, which has been a very reliable indicator of recession risk, is close to being triggered. However, this remains a close call. While there are cracks emerging in the labor market and broader activity, the economy has been remarkably resilient in the face of higher rates and this dynamic could persist. Moreover, strong progress on inflation has increased the scope for the Fed to deliver pre-emptive easing in early 2024 in response to signs of economic weakness. This may prevent a slowdown turning into a recession.

2. Is the final mile of bringing inflation down going to be the hardest?

Central banks have been vociferously pushing a 'higher for longer' message: policy rates will need to be kept elevated since their credibility is at stake and 'the last mile' of the inflation fight will be the hardest. But will it?

The rapid downward move in headline inflation has been helped by energy base effects as the big spike at the start of Russia's invasion of Ukraine dropped out of the year over-year comparison. And global goods inflation fell dramatically as supply chains normalized after the pandemic. These ‘easy gains’ are now in the past.

A number of major economies – such as the US, Canada, the UK and some emerging markets (EMs) – continue to run uncomfortably high rates of wage growth and core inflation. But the bigger picture is that the speed of underlying disinflation globally has also been remarkable and shows no sign of slowing down (Chart 2). Indeed, the median month-over-month rate of core inflation across both EMs and DMs is now around target-consistent levels. And prior disinflations over the last 30 years show little tendency for core inflation to reaccelerate.

We suspect many central banks and forecasters will be surprised by how low inflation falls in 2024.

Source: Haver, abrdn, December 2023.

3. Will interest rates remain higher for longer?

We believe interest rates have peaked across much of the developed world, with the notable exception of Japan (Chart 3).

Source: Haver, abrdn, December 2023.

Policy makers will continue to point to the possibility of further rate rises, but this should be thought of as part of the complicated interaction between policy communication and financial conditions. By keeping the possibility of further hikes alive, central banks hope to keep financial conditions tight now. However, absent a large inflationary shock, we think the hurdle to further rate increases is significant.

Indeed, we believe rate cuts will start around the middle of 2024. In the UK and the Eurozone, this would represent a relatively long period to keep rates on hold given economic weakness. In the US, we expect cuts to begin around the time the economy falls into recession, although the chance of earlier "precautionary" cuts is rising.

We believe these cutting cycles will be more rapid, and reach a lower level, than markets price. This reflects our judgment that equilibrium policy rates remain low amid ongoing structural headwinds. But, while r* is still low, the term-premium component of bond yields may be moving structurally higher.

4. Will China suffer Japanification?

Struggles in the property sector, tensions with the US and negative inflation have raised comparisons between China and Japan’s ‘lost decades’.

Engrained deflation would be very damaging for China. Real rates would rise, weighing on economic growth, and this could set the stage for a balance-sheet recession in which the state struggles to offset a private sector retrenchment. The Chinese Communist Party's (CCP) policy bias for supply-side stimulus makes this a long-term risk that is hard to fully discount, and a balance sheet recession is an alternative scenario we formally consider. But there are good reasons to think these fears are overblown.

First, falling food prices and energy base effects account for much of the recent deflation. Fading base effects should push headline inflation back up in 2024 (Chart 4).

Source: Haver, abrdn, December 2023.

Second, balance sheet recession dynamics are unlikely given state influence on the banking sector, a closed capital account, and policymakers' awareness of the lessons from Japan. And, even though we have marked down potential growth due to the difficult real estate adjustment, China is not a rich country as Japan was when it ran into trouble. China should, however, still become the world's largest economy by around 2035.

5. How deep will the Eurozone recession be?

The Eurozone is likely to enter 2024 in technical recession. Indeed, the bloc's economy already contracted by 0.1% in Q3 2023. This weakness is the result of the European Central Bank's hiking cycle, the impact of the Russia/Ukraine energy shock, the weakness of China as a source of export demand, and structural headwinds to parts of the auto industry. Many of these drivers have hit Germany particularly.

That said, forward-looking indicators suggest that, while economic weakness isn't over yet, further rapid deterioration from here is unlikely. One reason why we expect the recession to be mild is the asynchrony of the current downturn across member states, which flatters the profile of aggregate Eurozone GDP. In addition, the return of positive real wage growth, amid the rapid decline in inflation but still strong nominal wage growth (Chart 5), should support personal expenditure in 2024.

Source: Haver, abrdn, December 2023.

On balance, we forecast a sluggish recovery from a mild recession. We see the Eurozone economy growing 0.5% over 2024 as a whole and the European Central Bank easing policy throughout the second half of 2024.

6. Will the Bank of Japan finally exit negative interest rates and yield curve control?

The pandemic and energy-related drivers of Japan's inflation overshoot are now unwinding. The true tests of whether Japan has transitioned to a new inflation regime are higher wage growth and inflation expectations.

Japan's largest labor union is targeting increases of "more than 5%" in 2024 wage rounds, given the current elevated rate of inflation and decent corporate earnings growth. But that doesn't mean realized wages will hit anything close to that rate. Indeed, August's core earnings were stable at just 1.6% (Chart 6).

Source: Haver, abrdn, December 2023.

Meanwhile, inflation expectations have picked up, but may be weakly entrenched given the historical experience. But there is a revealed preference from the Bank of Japan (BoJ) to pull back from current policy settings given concerns about yen depreciation and broader market functioning.

On balance, we expect the central bank's exit path to be very cautious. We also believe that another decent Shunto wage round could prompt the BoJ to drop yield curve control and raise the policy rate to 0% around the middle of 2024. We do not envisage further rate hikes over our forecast horizon, so Japan may only be replacing negative rates with zero rates.

7. Who will win the US Presidential election?

Donald Trump is almost certain to win the Republican Primary. He holds a nearly 50 percentage point lead over his nearest rival. By contrast, the general election will be highly competitive, with the electoral college vote likely to be decided by voters across the six principal swing states in the Midwest and South.

As things stand, polls indicate Trump would flip enough of these states to win the 2024 Presidential election. High inflation during Biden’s presidency has hurt his approval ratings, as has growing concern about his age (Chart 7). The US entering a recession next year would compound these headwinds.

Source: RealClearPolitics, abrdn, December 2023.

Trump has his own electability issues. He will remain on trial for the duration of the race and may have received verdicts in some of the cases. Any guilty verdicts are likely to harm his standing with independent voters, who are concerned about his fitness for office.

With both candidates suffering from negative approval ratings and addressing unusually significant competency questions, the election is likely to remain on a knife edge. But, for now, our expectation is a Trump victory.

8. Will the world deglobalize?

Our globalization index points to a stagnation in the traditional engines of globalization: trade and capital flows (Chart 8).

Source: Haver, abrdn, December 2023.

Politicians' increased focus on national security, and firms' desire to improve their own resilience and shield themselves from geopolitical fallout, have the potential to throw globalization into reverse.

The outcome of the US election will be a key factor. A second term Biden presidency would continue to encourage the “friendshoring” of strategic supply chains, maintaining the “small yard, high fence” strategy that is focused on restricting China's access to high-end technology.

Trump, on the other hand, would likely use across the board tariffs, impacting a wider range of countries.

While significant amounts of onshoring aren't yet showing up in macro-level data, Mexico is already benefitting from a reconfiguration of supply chains, while geopolitics could push investment out of China and into the rest of Asia. Indeed, APAC's centrality within the global trade network provides it with a strong advantage, as manufacturers there do not need to “nearshore” to gain access to the fast-growing consumer markets of China and Asia more broadly.

9. How large will the Labour victory in the UK be?

Despite multiple attempted ‘resets’ this year, the UK Conservative Party has been unable to make headway on Labour's 20-point lead in polling averages.

With less than a year to go until the likely timing of a general election, a Labour victory is very likely. The size of its majority, however, is probably being overstated in many reports.

There are two main factors at play. The first is Labour's poor performance at the 2019 general election, meaning the party needs a historically large swing for a majority in 2024 (Chart 9).

Source: Commons Library, abrdn, December 2023.

Second, most polls exclude respondents who say they do not know who they will vote for. Currently, 21% of those who voted for the Conservatives in 2019 state they do not know how they will vote. The behavior of this group, not yet captured in headline polls, will have a major influence on the result.

A majority of more than 20, which nonetheless looks possible, would enable Labour to govern without internal opposition affecting its ability to pass legislation. A single-figure majority, or a government supported by smaller parties, would find it significantly more challenging to pass reforms promised by Starmer.

10. Are we on the cusp of an artificial intelligence (AI)-driven productivity boom?

Developed economies have been stuck in a period of low productivity growth since the global financial crisis (Chart 10). Drivers include exhausting the low-hanging fruit of past innovations, fewer spillovers from globalization, and demand deficiency. However, mismeasurement may be slightly overstating this slowdown. Technological changes of the past few decades, including smartphones, e-commerce and cloud computing, have had limited impact on productivity growth. But this shouldn't be extrapolated to mean a productivity boost from AI is not coming.

Source: Haver, abrdn, December 2023.

The “Solow paradox” referred to the absence of a productivity boost from the computer revolution of the 1970s and 80s, which then showed up in the 1990s. The eventual boost was worth around an additional 1% of productivity growth per annum for almost two decades. This delayed – but eventually transformative – impact is a hallmark of a “general purpose technology”. AI could share many of the same features – pervasiveness, continuous improvement, and innovation spawning.

We are, therefore, cautiously optimistic about the eventual positive productivity impact from AI. Meanwhile, we think worries about aggregate job destruction fail to take account of the productivity enhancement and job creation channels of technological change.

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