By Vishwanath Tirupattur, global head of Quantitative Research at Morgan Stanley
Later today, we will publish our year-ahead outlook. Personally, it is a milestone – it is the 20th year that I have had the privilege of being part of this annual crystal ball-gazing at Morgan Stanley Research. For those of us steeped in the daily grind of the markets, stepping back and imagining how the economies and markets evolve over the course of the year ahead is a challenging endeavor, and one we take seriously. We strive to achieve cohesion and consistency in our outlooks across economies and markets through a highly collaborative and deliberative exercise involving our economics and strategy teams globally.
Our economists led by Seth Carpenter, Morgan Stanley’s chief global economist, expect below-trend growth in developed markets (DM) and a mixed growth picture evolving in emerging markets (EM). They see restrictive monetary policy of the last two years continuing to exert pressure on the global economic cycle over 2024. Positing that while global inflation has peaked, returning to target levels will take a period of below-par growth, they expect to see global growth slowing with most DM economies avoiding recession while taming inflation. They acknowledge that while recessions remain a risk everywhere, any recession in our baseline scenario (such as in the UK) should be shallow as inflation is falling with full employment, so real incomes hold up, leaving consumption resilient, despite more volatile investment spending.
The risk of a debt-deflation trap remains in place for China, resulting in a subpar improvement in both growth and inflation which weighs on headline growth in EM.
While growth remains robust in select EM economies such as India, Indonesia and the Philippines, it won’t be sufficient to offset the drag from China.
After nearly two years of aggressive monetary policy, our economists expect policy rates across most DMs, with the notable exception of Japan, to remain broadly on hold in 1H24 and decline only gradually as inflation cools towards target levels.
Thus, despite the start of easing. policy rates in DMs remain restrictive even at the end of 2024. Japan continues to play to a different tune, inching towards policy normalization from the other end of the policy spectrum. Our economists expect the BoJ to remove both the Negative Interest Rate Policy (NIRP) as well as Yield Curve Control (YCC) in January 2024 and hike once in July 2024.
For markets, 2024 presents a challenging set-up. Many markets have already priced a smooth macro transition, a soft landing characterized by moderating growth and inflation and eventually easier policy.
Thus, justifying current valuations across many asset classes requires the macro outlook to stick the landing perfectly. In that sense, there is little room for error. Unlike the last two years when we had a strong preference for RoW over US, we expect that US assets will find 2024 easier, and EM markets less so. In currencies, we expect that USD strength endures through 1Q, as growth and rate divergence continue and USD's defensive characteristics remain alluring. JPY outperforms on the back of the BoJ exiting YCC and NIRP.
A slowing economy and policy easing set the stage for yields to be lower in the US, Europe, the UK and the dollar bloc, and yield curves to steepen. We think that this is a good set-up for 'income investing'. For yield-focused investors seeking 6%+ yields, we see a wide range of opportunities across high-quality fixed income – DM government bonds, IG credit, agency MBS and senior tranches of securitized credit.
Given that there is little room for error, we lean towards a defensive posture, particularly in equities. Japan is our most preferred region while EM is our least preferred, dragged down by Asia growth. For US equities, we continue to recommend a defensive growth and late-cycle cyclicals barbell and look for a durable earnings recovery to emerge during 2024 even as we expect the earnings recession to continue in the short term. Meanwhile, we expect European equity earnings to trough in 1Q, but any recovery is likely to be L-shaped.
2023 has been a challenging year for markets and 2024 won’t be easy either, but we expect the nature of the challenge to be different.
You will get the full story in our global outlooks coming out later today and more detailed asset class-specific outlooks that follow. Stay tuned.