“High for longer” for the Fed and ECB should disappoint equities and bonds in the 1Q, although Japan has a more positive story.

Our September meeting’s overall theme of “Good but rocky rebound from a weak 3Q, with a rising yen” seems to have been, so far, somewhat too cautious on overall global economic growth. Regarding recent growth in the Eurozone, the current consensus is lower than our consensus-like view at the time, but the converse is true for the US, Japan and China, where consensus is slightly higher than before. Our consensus-like call for central banks through September 2024 appears so far quite correct for the ECB, but consensus now for the Fed is much more dovish than expected, whereas the BOJ situation is unclear. We expected significant deceleration in global inflation, and current consensus for the US CPI nearly exactly matches our targets, but central banks and markets deemed such to be excellent progress, so they enthusiastically expect continued deceleration. As for bonds, US and Eurozone yields fell in 4Q much more than we expected (while our BOJ forecasts were close to our target) and our 6-month view of declining US and Eurozone yields was in the right direction. Meanwhile, the USD was weaker than our expected “mixed”/ flattish trend, but we accurately emphasised that the yen would start a significant rising trend in the coming quarters, estimating 142 in June. Our geopolitical backdrop has seemed correct so far, with no market-shaking political upheavals. Obviously, the Israeli-Hamas war was a surprise, yet it has not greatly affected markets after a short downdraft. As for markets, MSCI World rose much more than our rather optimistic stance, but this was almost entirely due to a strong US market, while our forecasts for the other markets were fairly accurate. We expected healthy gains for WGBI, but such turned out even higher, partly due to the weaker USD. Global equities greatly outperformed bonds, as we expected. Meanwhile, commodities declined much more than our modestly negative forecast through the 4Q, with oil sinking, while most other commodities were flat or down.

Looking forward, on 19 December, our committee narrowly decided on a macro-economic scenario (among the six presented) in which the global economy matches the current sluggish consensus, but that the Fed and ECB are slower to cut rates than the market expects. We also expect geopolitical risk to negatively affect markets in the coming quarters and that economies and trade will be partially disrupted by such. As an important sidenote, the scenario that was close to being chosen was the fully consensus-like scenario, with rather aggressive ECB and Fed rate cuts, coupled with much less geopolitical risk, so if our scenario choice is wrong, global equity and bond markets will likely be much stronger than we expect.

There are many reasons, which we agree with, for the rather sluggish consensus forecasts for global economic growth ahead. In Europe, part of the problem lies with the restructuring of the economy relating to the Ukraine war, while in the US, high interest rates, resumed student loan repayments and a partial government shutdown should continue to dampen growth in the 1Q. Although greatly forgotten in recent weeks, the financial and real estate sectors’ troubles in the West continue to play a role in weakening the economy and restraining business optimism. As for other credit-related issues, private lending, private equity, commercial real estate (including CMBS and bank lending to such) will likely encounter continued trouble and default rates more broadly are expected by rating agencies to continue increasing. Of course, markets are now more attuned to the risks in commercial real estate, but given that it is fairly opaque, with booked prices often lagging reality, and that it is one of the largest asset classes in Western economies that is deeply entwined with both large and small banks, it is highly likely that the risks are underappreciated, especially as conditions in several of its subsectors are further worsening to distressing levels, at least in the office sector, in the US and Europe. Other property sectors’ pricing is also hit by higher interest costs as well as higher cap rates, although clearly, the recent decline in bond yields is helpful. The risks are even more serious now that bank regulators will finally be more diligent regarding the pricing of assets and the sectoral concentration of risks, while banks will very likely be turning much more cautious anyway and forced to charge higher rates to clients given that funding costs are rising. On the positive side, we expect global labour market tightness to ease somewhat and oil prices to decline a bit further. However, one way that the Fed and ECB will likely justify for their slower cuts is that labour costs are not decelerating enough, likely due to major recent wage agreements (and minimum wage hikes) in recent months (and perhaps more to come). These clearly have second-round effects that also must be carefully monitored. It is also possible that the Fed will be wary of cutting rates too much in the 2H lest it be accused of influencing the elections.

Given this backdrop, our scenario predicts that globally, GDP will virtually match consensus in the next four quarters. Thus, we forecast: US GDP up 1.1% on a Half on Half Seasonally Adjusted Annualised Rate (HoH SAAR, as used in all references below) in the 1H24 period and 0.7% in the 2H24 period; Eurozone GDP at 0.4% and 1.0%, Japan at 1.2% and 1.2%, and China at 4.9% and 4.8%, respectively. For CY23 GDP growth, the US, the Eurozone, Japan and China should be 2.3%, 0.5%, 2.2% and 5.2%, respectively, with CY24 at 1.5%, 0.5%, 1.1% and 4.8%. Clearly, consensus remains quite subdued for the G-3 economy, with several major firms’ economists still predicting recessions. As for China, we continue to expect a moderate amount of economic stimulus ahead, with the central government also alleviating the debt burden for local governments, but not “spoiling” consumers with fiscal largesse. The property market is clearly a very large concern, especially given the large number of empty units held for investment, but we see some stabilisation ahead, with the government now deeply committed to preventing a larger problem, especially now that such is continuing to cause visible problems in the trust and wealth management industries. Unfortunately, as explained below, continued economic growth does not mean that geopolitical relations will be stable. Indeed, such will cause continued mutual inefficiencies, trade retaliation efforts and other unhelpful aspects for both the OECD and China.


Not only will the Ukraine conflict continue to be a major problem, but North Korea, China/Taiwan and the Middle East require close monitoring. Taiwan’s election in January is likely to be a major pothole, as a firm anti-reunification candidate is very likely to win, thus upsetting China. Although we usually expect geopolitical issues to only cause market volatility and worrisome rhetoric, the election is likely to cause deeper and longer economic ructions and curtail business and investor confidence globally, as both Taiwan and China are obviously key cylinders in the global economic engine. While an invasion or blockade is very unlikely, rather significant other disruptions to their relationship, and that with the OECD, are quite likely. Meanwhile, Middle East problems are also disrupting trade to some extent and could well continue to do so.

As for US political risk, the country remains mired in conflict, and we expect continued turbulence. House Republicans will continue to investigate President Biden, which will likely prove very unsettling, and the upcoming election will likely be fraught with shocks. The net result of all of this should make risk markets and business leaders somewhat wary, but normally, as long as the economy and corporate profits are not impacted by political turbulence, US markets should not overreact too much. We expect annual fiscal appropriations to squeak through just like the debt limit did, but it will likely be a very ugly process, with some period of shutdown for the federal government. European political affairs should also be somewhat turbulent, and markets seem complacent about the prospect of a UK Labour government. War and immigration weariness is spreading and the election of relatively right-wing governments, including now in the Netherlands, should keep political divisions very high, which is further amplified by the unrest caused by the Israel-Hamas war, given the large Muslim populations now existing in Europe. We discuss Japan’s political situation in its equity section below.

Our detailed forecasts:


Central banks: Fed and ECB less dovish than consensus, while BOJ tightens

Our new view on monetary policy is much less dovish than consensus, as we expect the Fed and ECB to cut only 25 bps in the 2Q and 50 bps in the 2H. We are, however, closer to consensus regarding the BOJ, with it likely ending YCC soon, ending ZIRP in the 1Q, then raising 20 bps in 2Q and 40 bps in the 2H. Furthermore, the Fed and the ECB will proceed with QT as currently planned. Besides the wage and second-round effect concerns mentioned above, the Fed and ECB will likely need to keep real rates somewhat higher than normal to counter the debt sustainability and other factors that are mentioned below.

US and European bond yields to tick up in 1Q, and then decline, with the yen stronger and JGB yields rising

We expect a surprisingly negative 1Q as the Fed and ECB guides markets, as they have already slowly started doing, away from strong dovishness. For bonds globally, this will push up yields slightly in the 1Q from mid-December levels. After this, however, low economic growth, financial sector and credit accidents, coupled with a continuing decline in inflation should help restrain yields, especially given the eventual ECB and Fed cuts. However, continuing QT and high issuance certainly will prove to be headwinds and we expect increased fears about debt sustainability, at witnessed by recent credit rating agency warnings, coupled with increased supply due to huge fiscal deficits to prevent bond yields from falling too fast. Furthermore, if there are large geopolitical tensions like we expect, some countries, like China, may wish to reduce exposure to long-duration USD assets. In sum, for US and German 10-year bonds, we expect rates to rise to 4.0% and 2.15%, respectively, by end March, but to decline 10 bps in each following quarter. Due to its converse monetary policy, those for Japan will likely rise gradually to 1.1% by the 4Q. Regarding forex, we expect the USD to be quite stable in the 1Q vs. the EUR but decline to 140 vs. the yen. Thereafter we expect moderate weakness vs. the EUR and the yen to rise to 134 by the 4Q for these reasons: 1) the BOP trade deficit in goods and services consistently returns to surplus (in October, it had its first in more than two years), with a further surge in tourism receipts as group tours from China resume (which used to account for about 50% of tourists, but has only slightly recovered so far), 2) a continued increase in foreign investment in Japanese equities, 3) a narrowing differential with the USD policy rate and longer-term (inflation-expectations adjusted) interest rates. One possible, but uncertain, headwind to yen strength is that Japanese investors, particularly in the newly expanded NISA tax-sheltered investment accounts, may invest large sums abroad.

In sum, we forecast that the FTSE WGBI (index of global bonds) should produce in USD terms a 0.1% unannualised total return from our base date of 15 December through March, 1.0% at end-June and 3.3% through December. Thus, we are not particularly positive on bonds over the full period. For yen-based investors, however, this index in yen terms should return -1.4%, -2.0% and -2.6% through those respective periods due to yen strength, which is quite unattractive. Meanwhile, with JGBs returning -0.8%, -1.5% and -3.0% in yen terms, respectively, a preference for short-duration yen assets seems quite apparent.

The Brent oil price will likely be very volatile but should decline to around USD 75 at the end of the next two quarters, with slight declines afterwards. The recent price decline after the Israel-Hamas war has been remarkable but speaks to the interest in global economic and financial stability by key OPEC producers. Gasoline prices in the US have been very weak too, which likely also reflects decreased consumption due to higher EV penetration and some reduction in transport usage. Of course, geopolitical questions loom large, both geopolitically and as regards global oil supply, but we think that supply will adjust to any troublesome conditions in relatively short order. We also expect that OPEC will hesitate pushing prices higher than USD 85 or so, lest a rapid shift to alternative energy occurs. Other commodity prices should decline mildly, in our view.

We expect US headline and core CPI to undershoot consensus estimates, with considerable deceleration ahead to 2.3% and 2.0% in June and December, respectively, for the former, and for the latter to 2.5% and 2.0%. Although this makes future real interest rates appear high, as mentioned above, such is likely necessary to counter debt sustainability and other factors. As for further details, housing rent will likely continue to decelerate, with airfares, apparel, home furnishings and many services prices softening too due to slower demand and lower input prices. Eurozone and Japanese CPIs should decelerate greatly ahead too, although the Eurozone will take even longer to approach the ECB’s target, as second round effects and labour strikes continue to be quite pervasive.

Equities should rebound after a weak 1Q

Our scenario entails some true headwinds for global equities, so we reduce our very positive view to a negative one for most of the 1H, but then a positive one for the 2H, with an overall neutral one for those investors who cannot make quarterly changes. Aggregating our national forecasts from our base date, we forecast that the MSCI World Total Return Index in USD terms will return -4.2% through March, -1.8% through June and +3.7% through December (-5.7%, -4.7% and -2.2% in yen terms). In the US, our equity team thinks this scenario will shock the market in the 1Q, with a decent recovery in the 2Q, followed by quite a strong 2H a to new high. The 1Q shock is due to the 4Q’s surge to a very high valuation based on an aggressively dovish Fed policy that we estimate will be reversed. Indeed, the SPX’s PER on its CY24 consensus EPS estimate is very high at 19.4, and, moreover, we see 2024 earnings disappointing consensus in this scenario. Continued credit accidents and geopolitical ructions will also hurt sentiment, especially in the 1H. Thus, in sum, we forecast the SPX as follows: down to 4,455 (-5.2% total unannualised total return from our base date) at end-March, then to 4,583 at end-June (-2.1% return) and to 4,831 at end-December (3.9% return), with yen-based returns of -6.6%, -4.9% and -2.0%, respectively. We expect the US to underperform global markets in the 1H, but perform inline in the 2H.

Even after a strong 4Q like we forecasted, European equities’ PER is only 12.7 times CY24 EPS consensus estimates, which is a bit below its historical average. A key factor for performance (along with, of course, the Russia-Ukraine situation) will be how pervasive labour strikes and the resulting wage increases are. We are a bit pessimistic on that front, given the confrontational socialist backdrop there, but we believe this problem will likely peak soon. Meanwhile, there could be some additional problems (after the recent collapse of one of the largest companies) associated with Europe’s commercial and residential property sectors that would likely cause some financial system troubles. In sum, similar to the US, given our more hawkish than consensus ECB forecast, we expect the Euro Stoxx index to fall to 455 at end-March and FTSE to 7,120, which translates to a total return of -3.8% (unannualised from our base date) for MSCI Europe in USD terms (with the Euro stable for this period). Further out, we expect 445 and 6,950, respectively, with MSCI Europe -6.0% through June (with a slightly stronger Euro), and -3.7%, through December, which argues for an overall underweight of the region but with some preference during the 1Q.

In USD terms, Japanese equities rose, but somewhat underperformed in the 4Q after doing fairly well earlier in the year. Importantly, corporate profit margins continue to hit new highs, greatly due to pricing power and continued improvement in corporate governance. Meanwhile, inflation, which has greatly worried consumers, looks set to decline ahead, especially given our anticipated rebound in the yen. Furthermore, we expect the oil price to fall further, which should also help consumer, business and investor sentiment. The auto sector, which is a major portion of the stock market and economy, is further recovering, with profits abroad helped by a weaker yen and the UAW strike pushing up costs for its Detroit competitors (as well as curtailing their production). Meanwhile, global tech sector demand is recovering, which should continue be a boon to Japan’s exports. China’s continued economic growth should also help Japan’s exports and its factories there. As noted above, tourism will likely be boosted by increased numbers from the crucial origin of China. Meanwhile, Japan has low political risk despite the possibility of new leadership ahead. The Kishida government has performed well in most respects, but consumer dissatisfaction about lower living standards may not be alleviated soon enough to save his government. However, the LDP will still likely control government (along with the ministries) and structural reform seems embedded in its veins, although the pace of such is uncertain. Because he is a very popular political figure among the public (although less powerful within the LDP), there is even a chance that Minister Taro Kono could lead the next government, which would accelerate reforms greatly. Thus, it seems relatively safe not to worry too much about politics in Japan (and our team is not much concerned about geopolitical effects on the market) and TOPIX’s PER is now 14.2 times its CY24 consensus EPS, which remains attractive. Meanwhile, our BOJ view is near consensus and thus, BOJ gradual tightening should not be a surprise. Also supporting the market are strong share buybacks and the market’s dividend yield, which at 2.3% remains extremely attractive vs. bonds. Thus, we forecast TOPIX to rise to 2,390 at end- March, 2,470 at end-June and 2,570 at end-December for total unannualised returns of 4.8% in USD terms (3.2% in yen terms), 10.4% in USD terms (7.2% in yen terms) and 19.5% (12.6% in yen terms), respectively, from our base date. As for the Nikkei, it should hit 33,700, 34,800 and 36,300, respectively. These returns are clearly very attractive for both domestic and global investors, so we have a heavy overweight stance on the market.

Developed Pacific-ex Japan MSCI: Australia will likely be hampered by declining commodity prices and less dovish global monetary policy, and our view is that trade ructions with China vs. the OECD will greatly impact investor sentiment and corporate profits in Australia. Thus, we expect the market to decline in the 1H and mostly stabilise in in the 2H. Meanwhile, our Asian equity team estimates a moderate gain in Hong Kong’s stock market in the 1Q, a stable 2Q and an increase in the 2H. The currently pervasively negative sentiment should lift due to China muddling through its current problems, and extremely low equity valuations should support the equity market. Hong Kong is also benefitting from a revival in tourism. In sum, we expect the region’s MSCI index returns in USD terms (total unannualised) at 0.0% through March, -1.8% through June and 0.4% through December. Thus, Developed Pacific ex Japan has some attraction relative to global equities in the 1H, but should be underweighted in the 2H.

Investment strategy concluding view

We expect poor 1Q returns for MSCI World after the 4Q surge, but a more positive trend for the rest of the year. Regionally, we much prefer Japan in the year ahead. Our view on global bonds for USD-based investors is that they are preferred during much of the 1H, but only marginally attractive in the 2H. Overall, this clearly leads to an underweight view for MSCI World during much of the 1H, then upgrading to an overweight view in the 2H. Our stronger yen scenario means, however, that Japan’s investors should overweight their own stock market, not only vs. JGBs and global bonds, but vs. overseas equities, as well. Meanwhile, returns from JGBs should be negative for Japanese investors, so short- duration yen assets should be preferred. As always, we can provide forecasts for our alternate scenarios upon request and remind our readers once again that the scenario that we were next closest to choosing was the fully consensus-like scenario, with rather aggressive ECB and Fed rate cuts, coupled with much less geopolitical risk; thus, if our scenario choice is wrong, global equity and bond markets will likely be much stronger than we expect.