(Source: Merlea Macro Matters)

Summary

As we reflect on the economic landscape spanning from mid-2021 to late 2022, it becomes evident that despite robust growth and a strong job market, overall sentiment remained bleak. Although this period didn’t fit the traditional definition of a recession, it exhibited economic distress akin to one. Inflation surged, real incomes dwindled for many, businesses encountered hiring challenges, and the stock market remained stagnant for two years. While some believe that short-term pain is necessary for future prosperity, akin to the “no pain, no gain” mentality, the aftermath of the 2008-2009 recession serves as a cautionary tale, with slow recovery and stagnant productivity.

Yet, amidst these challenges, there’s hope for better long-term trends. A tight labour market often leads to investments in productivity enhancements and provides valuable skills and experience. Additionally, household balance sheets remain resilient. Therefore, while the period from 2021 to 2022 resembled a recession in terms of dissatisfaction and losses for many households, there’s potential for these challenges to foster enduring strengths and opportunities in the future.

Looking ahead to 2024, the global economy enters a delicate stage of post-pandemic rebalancing. Growth is expected to slow below trend before pivots in monetary policy steer economic activity to a more sustainable path. Disinflation is anticipated to persist, albeit at a slower rate and on a more erratic trajectory. However, several factors, including lagged effects of monetary policy, global conflicts, structural changes in China, and elections in key economies, pose uncertainties to the economic outlook.

Regarding the Australian economy, the outlook remains soft. Data for the December quarter of 2023 is expected to reveal economic growth dipping below 2% for the first time in three years. The tightening monetary policy by the Reserve Bank of Australia has strained many households, offsetting spending from migrants and older Australians who have avoided mortgage rate pain. If realised, the forecasted growth of 1.3% in 2024 would be the weakest since the early 1990s recession, making it feel like a recession despite the economy technically growing.

With the disruption of COVID-19 behind us, the primary economic challenge for Australia by the end of 2024 is expected to shift from lowering inflation to lifting growth. This would require economic reforms, with tax policy topping the list. Industry-wise, while some sectors like mining have defied soft global demand, others like retail face persistent cost-of-living pressures. The education industry experienced a robust recovery fuelled by a surge in international students in 2023, while residential construction struggles to keep pace with population growth.

As we continue to navigate the economic environment in 2024, uncertainties abound, but opportunities exist for resilience and growth, contingent upon proactive policy measures and adaptive strategies.

Bonds

Although headline inflation is expected to drop, we look for a fading of goods price deflation. At the same time, tight labour markets and solid demand growth is expected to limit disinflation in service prices. Divergence between core goods and core services inflation has widened in recent months. Core goods prices have stalled, reflecting the broader disinflationary impulse from weak manufacturing activity, and falling China export prices. However, while much of the recent inflation slide has stemmed from goods prices, a key risk for the new year is a reversal of these price declines. For instance, recent shipping and airfreight cost indicators have moved up and delivery times have started to lengthen again. Core goods prices will likely return to modest positive gains in the first half of 2024.

On the other hand, the strength in core services inflation remains striking and is uniform across regions, reflecting still-tight labour markets. More noticeable cooling in labour markets may be required to bring core services inflation meaningfully lower and ratify market expectations for early easing by developed market (DM) central banks. Economists forecast only a moderate slowing in service price inflation to 4% in the first half of 2024.

Progress on lowering inflation from its 2021–23 heights should allow the Federal Reserve and other major central banks to ease policy. But our forecast of firming core goods inflation and sticky service price inflation will likely limit the size of this easing relative to current market pricing, absent a more tangible threat to growth,

As we navigate through today’s economic landscape, it becomes increasingly evident that historical patterns hold significant sway over our future expectations. Over the past five decades, each recession in the United States has been heralded by a yield curve inversion or negative term spreads. Since 1900, the yield curve has inverted 28 times, with recessions following on 22 occasions. Notably, there’s typically been an average lag of 22 months between the inversion and the onset of a recession.

Currently, the US Yield Curve has been inverted since July 2022, indicating a potential recession around May 2024, aligning with Fed guidance. Similarly to the dovish signals from the Fed and hints at rate cuts, the European Central Bank (ECB) is under mounting pressure to consider rate reductions due to weakening economic momentum in the eurozone.

While the impact of high interest rates varies across economies, the likelihood of a steep decline in rates is decreasing, signalling a departure from the near-zero rate era. Looking ahead 2024, 10-year US Treasury yields may stabilise within a range historically considered normal before the global financial crisis, hovering between 3.5% to 5.5%. This anticipated return to the “old normal” mirrors historical trends where rates typically ranged between 3.0% to 6.0%.

Despite the potential challenges posed by rising rates on financial markets, historical evidence suggests that investors tend to adjust to such environments. At the conclusion of rate-hiking cycles, there emerges a critical opportunity for investors to reallocate funds into stocks and bonds. Historically, this transition period has lasted an average of 10 months, during which both asset classes have outperformed US Treasury bills significantly.

However, it’s vital to assess the implications of a flat yield curve, indicating minimal spreads between short-term and long-term interest rates. A flat yield curve can signal several economic phenomena, including uncertainty, expectations of slower growth, the potential for a recession, and tightening monetary policy. While it doesn’t guarantee an immediate economic downturn, it serves as a cautionary indicator of potential challenges ahead.

As global bond yields, particularly in the US, are expected to trend lower, investors should look for opportunities to re-position their portfolios and take on longer duration risk. The Federal Reserve’s aggressive tightening measures are likely nearing conclusion, driven by a clear decline in inflation. Despite the resilience of the US consumer and labour markets, questions linger about the sustainability of this trend, potentially necessitating future rate cuts to mitigate a sharper downturn.

Listed Property

ASX-listed property stocks have endured significant challenges amid two years of high interest rates, but there’s optimism brewing as inflation shows signs of easing more rapidly than expected, potentially paving the way for rate cuts this year. Australia finds itself 18 months into the most rapid interest rate surge on record, prompting a revaluation of market dynamics.

The listed property market has undergone a repricing, with shares trading at a considerable discount to their net tangible assets. Simultaneously, credit markets have also recalibrated, with borrowers facing wide margins due to capital scarcity, particularly for real estate projects. This structural market dislocation has elevated the cost of capital, undervaluing some real estate assets compared to other points in the rate cycle, presenting opportunities.

The outlook for real estate investment trusts (REITs) has turned decidedly bullish among analysts and fund managers as the sector approaches its annual earnings season. Accelerated inflation easing has bolstered expectations for rate cuts, which could benefit the real estate sector closely tied to debt costs. Yields on long-term bonds serve as critical indicators for anticipated returns from REIT stocks. Bank economists anticipate the cash rate, currently at 4.35 per cent, to decrease to 3.85 per cent by year-end.

As rates peak, the sector historically exhibits a negative correlation with bond yields and interest rates, benefiting from both the plateau at the top of the interest rate cycle and the subsequent decline. Analysis suggests REITs typically start to outperform the market up to four months before the RBA begins cutting rates. Industrial stocks like Goodman, along with diversified developer Stockland and Westfield owner Scentre, are poised to benefit from the fall in bond yields and interest rates.

While there’s cautious optimism that the wave of downgrades reported in last year’s results has mostly subsided, upgrades may still be premature as listed property firms continue to manage expensive debt portfolios, potentially impacting earnings.

This presents an opportune moment to position portfolios for the next growth phase, focusing on alternative real estate sectors like childcare, healthcare, retirement living, and data centres, which are less cyclical than core assets such as office, retail, and industrial spaces. Major residential developers such as Stockland and Mirvac stand to gain momentum due to the country’s housing undersupply and robust population growth.

Considering the potential for consolidation, takeover activity in the listed property sector is unlikely to be prominent in 2024. Investors should assess A-REITs’ positioning and balance sheets to seize market dislocation opportunities and prepare for the next phase of the cycle.

Australian Equities

Lower-than-anticipated annual inflation has sparked a surge in risk appetite, with traders betting on a dovish stance from the Reserve Bank of Australia (RBA) in the latter half of 2024. Yearly headline inflation dipped to 4.1% in the December 2023 quarter, down from 5.4% in 3Q23 and below the projected 4.3%. This marks the lowest quarterly inflation since 4Q21. Quarter-on-quarter inflation slowed to 0.6% from the previous quarter’s 1.2%. Goods inflation decreased for the fifth consecutive quarter, while services inflation moderated for the second quarter.

The RBA opted to keep the benchmark rate steady at 4.35%, with commentary offering no significant surprises, acknowledging that inflation remains elevated.

While the RBA’s decision and commentary, including Governor Michele Bullock’s press conference, didn’t cause major market disruptions, the central bank hinted at the possibility of further rate hikes. However, traders appear unconvinced about the likelihood of additional hikes and have scaled back expectations for the timing and extent of rate cuts later in 2024. The RBA projects inflation to return to the target range in 2025 and hover around the midpoint (~2.5%) in 2026.

Ms. Bullock highlighted that while wage growth remains robust, there are signs of slowdowns in certain labour market segments. Additionally, services price inflation, reflecting domestic economic conditions, remained high and in line with expectations.

Regarding inflation, Ms. Bullock emphasised the need for convincing evidence of sustained decreases before considering rate cuts.

The probability of a rate cut in June has decreased following recent developments, but markets are fully pricing in a 25-basis point cut in September, although expectations for another cut before year-end have diminished.

As earning season progresses, the ASX200 closed marginally lower, with individual stock movements varying. Despite some disappointing performances, more companies have exceeded expectations than missed them.

Consumer sentiment reached a 20-month high, offering some positive news amid downbeat housing approval figures for December, which saw a significant decline, particularly in approvals for apartments. Consumer sentiment saw a notable improvement in February, attributed to easing inflation and the perception that the RBA has completed its tightening cycle. However, business confidence remains below the long-term average, with manufacturing and construction sectors showing more resilience than retail. Labor cost growth remains steady at 2%, while purchase cost growth has slightly accelerated.

While we believe that economic growth will continue to slow for at least the first half of 2024 (in Australia and in large parts of the world), we don’t think that Australia will move into a recession. Unemployment remains low, and the resumption of strong immigration and population growth will likely underpin the economy.

Sectors like insurance, building and construction, communications, healthcare, diversified financials, and some consumer staples should remain strong or improve through the remainer of 2024.

Although the ASX200 is displaying signs of fatigue at record highs, there is potential for a historic breakout, with strong support at 7000. The market is anticipated to reach new highs, supported by major mining and bank stocks and underpinned by the robust domestic economy, although a correction of over 5% could precede this.

Global markets

In 2024, global equity markets are experiencing a positive start, driven by expectations of lower inflation and reduced benchmark rates by central banks worldwide. Despite already high valuations in U.S. markets, investors are optimistic about sustained growth driven by earnings. Broad participation in the bull market is seen as a key indicator of market health, with individual stocks offering potential for multiple expansion and earnings recovery. In the U.S., strong growth and declining inflation create a favourable environment for both bond and stock markets. Despite neutral expectations, markets may experience volatility. Sustained earnings growth and closer alignment with the Fed’s inflation target should stabilise equities and bond yields.

European equities, though cheaper than U.S. counterparts, face challenges due to slower earnings growth and lack of dominant industry players. However, low valuation levels suggest potential for multiple expansion with central bank easing.

In Japan, a weaker yen and loose monetary policies benefit large exporters, but domestic companies may struggle with earnings growth.

Chinese equities have seen below-trend economic and earnings growth, exacerbated by unfriendly government policies deterring foreign investors.

Maintaining an underweight position in emerging market equities is advisable until supportive policies emerge.

America

The American financial markets present a curious scenario at the outset of 2024. While U.S. stocks surged to new heights in February driven partly by optimism about overcoming inflation and averting recession, derivative traders are placing bets on significant interest rate cuts by the Federal Reserve. This discrepancy suggests conflicting views on the economy’s trajectory, with one camp likely to be proven wrong.

The S&P 500 Index has kicked off 2024 with remarkable gains, surpassing year-end forecasts and hitting record highs. Much of this ascent has been attributed to a handful of technology giants, overshadowing the performance of other S&P 500 constituents. However, despite concerns about the market’s reliance on a few key players, index funds remain buoyant as the collective valuation of S&P 500 components stands at around 20 times expected earnings for 2024, well above the historical average.

The “Magnificent Seven” last year returned 76% as investors bet that they would be the main beneficiaries of a boom in artificial intelligence. The other 493 members of the S&P 500 returned just 14%, according to Goldman Sachs analysts. So far this year, the seven are up 8%, versus 3% for the rest.

The divergence in market sentiment is evident in expectations regarding interest rates. Derivatives markets are pricing in multiple rate cuts by the Fed, signalling pessimism about economic prospects. In contrast, equity markets remain optimistic, with analysts forecasting robust earnings growth and positive economic indicators, such as GDP growth and low unemployment rates.

Federal Reserve Chair Jerome Powell is expected to tread cautiously, considering the political scrutiny surrounding Fed decisions leading up to the U.S. presidential election. While the Fed has maintained a balanced stance in its recent communications, citing the need for sustained disinflation progress before considering rate cuts, economic data continue to paint a mixed picture.

Despite strong job growth and low unemployment rates, concerns linger about wage growth and the sustainability of labour market strength. A gradual reduction in the policy rate is anticipated to address these concerns and support economic stability.

In summary, while financial markets rally to new highs, underlying uncertainties persist, prompting careful monitoring of economic fundamentals and Fed policy decisions in the months ahead.

Europe

In the economic landscape of the Eurozone and the UK, the journey towards achieving inflation targets is gaining momentum, albeit with some monthly fluctuations. Forecasts suggest that Consumer Price Index (CPI) inflation is poised to reach the central bank’s coveted 2% target in both regions this year. However, alongside anticipated stagnant GDP growth, our projections indicate a softening in the interest rate outlook.

We have adjusted our 2024 average CPI inflation forecasts downwards by 0.4 percentage points in the Eurozone and by 0.9 percentage points in the UK. Consequently, we anticipate the European Central Bank (ECB) and the Bank of England (BoE) to initiate interest rate cuts from the second quarter of 2024 onwards. Our revised forecasts anticipate a reduction of 75 basis points each in their year-end policy rates, settling at 3.0% and 3.75% for the ECB and BoE respectively.

Additionally, analysts anticipate a decrease in their projections for year-end 10-year sovereign bond yields compared to current levels. While we continue to hold a growth outlook for 2024 that is below consensus, we acknowledge the potential threat posed by wage growth, especially in its role in supporting services inflation and potentially prolonging the period before interest rate cuts. Economists are forecasting a combined 150 basis points cut in interest rates by both the ECB and BoE this year, aiming to reach the neutral rate by 2025 as they anticipate the reversal of historic policy rate hikes. However, recent unexpected declines in inflation and consistently weak growth forecasts argue compellingly for such adjustments.

In the UK, CPI inflation is expected to reach the BoE’s 2% target as early as April, propelled by the reset of the Ofgem energy price cap, which will lead to reduced consumer gas and electricity prices.

While GDP growth expectations remain below consensus, recent indicators, such as the European Commission consumer confidence index, suggest a potentially delayed recovery led by household consumption. Despite the uptick in real wages, economic activity seems subdued, raising questions about the sustainability of restrictive monetary policies.

The European labour markets wield considerable influence over inflation, growth, and interest rates in the short term. Despite displaying resilience compared to weak economic activity, signs of softening are anticipated, strengthening the case for interest rate cuts this year.

Euro zone wage growth is likely to peak early this year, but the path further ahead remains uncertain. The ECB has singled out wages as the single most important variable in determining whether it can start cutting interest rate and call time in the fight against high inflation.

As analysts closely monitor wage negotiations, particularly in Germany, and anticipate labour market adjustments in the UK, they acknowledge the evolving dynamics that will shape economic outcomes. Moreover, with European Parliamentary elections looming, the policy priorities established by the new Parliament will shape the long-term outlook, focusing on the 4Ds: Decarbonisation, Digitalisation, Demographics, and Debt.

In conclusion, while uncertainties persist regarding the timing and pace of interest rate cuts, analysts remain committed to providing insightful analysis and forecasts to navigate these dynamic economic environments.

Japan

Japan’s policy makers want to see an end to structural deflation and a more permanent shift to steady economic growth. Inflation has returned and in fact reached a 40-year high in 2023. Business-to-consumer price hikes are steadily feeding through. Japanese newspapers have been filled with “shocking stories” on double digit price increases for food staples last year. But prices for many everyday products remain low, particularly when compared to overseas prices. For a nation that has experienced three decades of persistent deflation, corporate and individual mindsets will take to time to adjust to this new environment. They are still some way off a full-scale acceptance of persistent price hikes and there are no clear signs in the data yet that the BOJ needs to tighten policy significantly. While the central bank increased its 2024 inflation forecast its prediction for 2025 CPI excluding fresh food and energy remains below the crucial 2% level.

Market expectations are for a BoJ exit of Yield Curve Control (YCC) and negative interest rate policy (NIRP) sooner rather than later. However, it is imperative to focus on what comes after any initial announcement. Even if the BoJ removes YCC and moves away from NIRP, policy makers have signalled that they will tread carefully and refrain from tightening policy too quickly – meaning investors should probably prepare for a lower-for-longer regime.

Market speculation surrounding monetary policy normalisation has fuelled the strong performance of Japanese banks which outperformed the wider market by over 75% between their 2020-low and the recent peak in November 2023. Given the more gradual approach to normalisation, better opportunities can be found within non-bank financials and other domestic assets such as railways and real estate. These are Value areas of the market that after an extended period of QE followed by the pandemic, remain attractively valued, but should also benefit from a shift towards domestic reflation.

The Japanese market therefore remains depressed relative to the US. Valuations are more compelling and contrarian. Almost half of the TSE Prime Index continues to trade below 1x P/B, compared to just 3% of the S&P 500, according to our calculations. Fundamentals are improving as corporate Japan remains unique in its exposure to the TSE-led revolution focused on corporate profitability and efficiency. Japan has historically tended to be known as a Value market and there has typically been more mean reversion. This is partly because, on average, Japanese balance sheets are stronger and management generally work hard on their recovery during challenging operating periods.

Despite the underperformance of Growth relative to Value through 2021, 2022 and 2023, the valuations of Growth stocks, as measured by multiples such as price-to sales, remain well above their longer-term averages. As discussed, the improvements in corporate value, driven by the corporate governance requirements, should continue to support the performance of Japanese Value stocks going forward.

The corporate governance revolution, relatively attractive valuations, a weak yen, rising inflation and ultra-loose monetary policy helped propel the market to a 33-year high. With these trends only just starting to bloom, the medium-term outlook appears positive. But as with all fascinating stories, there will be twists and turns along the way. The fragility of Japan’s developing cycle of rising prices and wages, the influence of China’s economic recovery on Japan and an upcoming US election could all spark macro volatility in 2024. The challenge now is for Japan’s long term improvement story continue to build momentum and provide the resilience to carry it forward.

China

The start of the year has presented significant challenges for China and Hong Kong stocks, with the CSI 300 experiencing a 6.2% decline and the Hang Seng index down by 12.2% in January 2024. This decline follows the decision of the People’s Bank of China to maintain current prime loan rates, signalling a cautious stance towards injecting additional stimulus into the economy amidst worrisome economic data.

On valuation alone, there can be little doubt: Chinese stocks are some of the most attractive assets available in global markets.

Multiple factors have eroded investor confidence in the potential profitability of Chinese enterprises. These include a sluggish economic recovery hindering short-term revenue and profit growth, as well as Beijing’s stringent regulatory measures, which have reshaped perceptions of profit viability across various industries.

Given the diminished investment prospects, companies operating within these sectors should consider returning cash to shareholders instead, a strategy already being adopted by some. Notably, both Tencent and Alibaba distributed dividends and engaged in share buybacks last year.

Nevertheless, Beijing is gradually easing its stance, intending to provide increased fiscal support to the economy and implementing clearer regulations, especially in areas like online gaming. Despite challenges, China’s economy retains significant growth potential, which should positively impact corporate earnings.

However, geopolitical tensions pose a more immediate concern. While these tensions do not directly affect corporate profits, they introduce a difficult-to-assess risk of international investors losing access to their earnings due to geopolitical upheavals, akin to what happened to foreign investors in Russia following its invasion of Ukraine.

Presently, the reduction of this risk through a decrease in geopolitical tensions appears unlikely. Nonetheless, this risk’s impact will be particularly significant when companies retain earnings for internal investment, as it makes potential cash flows to investors uncertain and distant.

The recent sell-off has triggered panic among investors, leading to increased selling pressure to maintain underweight positions in China and adhere to volatility controls, further denting confidence. However, it’s essential to consider the broader context.

China’s economic cycle differs from the West, with the government focusing on stimulating investment and consumption to achieve stable GDP growth of around 5%. Discussions regarding the establishment of a stabilization fund for stocks are ongoing, but significant stimulus measures like the past are improbable, as they may undermine the government’s long-term economic objectives.

Nevertheless, targeted support for the property market and a shift towards growth-oriented policies pave the way for a potential recovery. Despite ongoing economic challenges, the substantial household savings accumulated during uncertain times hold the potential for increased consumer spending once confidence is restored.

Despite persistent volatility, opportunities for long-term investors lie in the resilience and adaptability of Chinese companies, evident through their corporate fundamentals. Their commitment to innovation and high-end manufacturing, reflected in research and development spending and global patent applications, positions them well for market share gains in fragmented industries and structural growth from urbanization and a growing middle class.

Promising opportunities also exist in healthcare sectors with low penetration, such as medical devices and core pharmaceuticals, as well as emerging sectors like the electric vehicle (EV) value chain, including battery manufacturers and auto parts suppliers.

Investors can now access these opportunities at compelling valuations, as indicated by measures like the 1-year forward price-to-earnings (PE) ratio for MSCI China, currently at 9 times compared to its 10-year average of 11.4 times.

Despite recent market turbulence, corporate China has repeatedly showcased its ability to innovate and thrive even in the toughest of markets.

Emerging markets

Recent shifts in global monetary policy have sparked changes in capital flows to emerging markets (EM). Since January, inflows into EM bonds and equities have declined significantly following the Federal Reserve’s revised expectations regarding the timing of rate cuts. However, amidst this development, there is positive news: current account deficits in EMs have narrowed over the past year, indicating reduced dependence on foreign inflows.

Looking ahead, we anticipate that EM equities will outperform in the next couple of years compared to their performance during the pandemic period. While returns may not match those of US equities, they are expected to be comparable to other developed market (DM) equities. EM Asia is poised to lead in equity performance, while Latin American markets may lag.

A notable observation from recent EM central bank decisions is a shift in focus towards domestically driven price pressures, diverging from the Federal Reserve’s stance. In the coming months, we anticipate a pivot towards monetary easing across much of Asia, with front-loaded rate cuts expected in countries like Chile and Czechia. However, central banks in other parts of Latin America are likely to maintain a cautious approach.

Moreover, we project that government bond yields in EM economies will decrease throughout the year. This trend is anticipated to be supported by a broader easing cycle across various regions and declining Treasury yields.

Commodities

Prices across various commodities have experienced fluctuations in recent months, with differing fortunes observed in different sectors. Notably, iron ore prices have shown remarkable resilience due to ongoing supply constraints. Conversely, crude prices have seen a recent weakening, although geopolitical tensions continue to pose upside risks.

While industrial metals and markets linked to the manufacturing cycle seem to have already factored in a significant portion of cyclical weakness, suggesting potential outperformance compared to other volatile markets in anticipation of a broader slowdown in 2024, we remain cautious until price action confirms this hypothesis, prompting us to cautiously consider increasing core long exposure for a cyclical rebound.

Regarding copper, despite experiencing a recoil within a broader range after encountering resistance near $4 in the fourth quarter, we maintain a bullish view, anticipating growing demand and supply constraints to drive copper prices above $4 per pound this year. The technical setup suggests a topside bias, with a breakout above $3.80 potentially leading to rapid price appreciation into the mid-$4 range.

Regarding iron ore, China’s efforts to close smaller, less efficient, and environmentally harmful steel production facilities persist. However, steel production levels defied expectations by remaining elevated in the first half of 2023, as indicated by CISA data. Although inventory levels have since normalised, raising concerns about iron ore demand amid a structural decline in steel production.

Over time, major iron ore producers such as BHP and Rio Tinto, while Vale’s production has been stagnant, have adeptly adjusted their output to match shifts in demand. Chinese imports of Australian ore reached a peak in 2020 and have since plateaued. This careful management of supply appears to be providing a solid foundation for iron ore pricing. While total ore imports have been increasing since 2021 driven by supplies from sources beyond Australia, they remain below the peak observed in 2020.

Gold

Gold prices retreated to US$2,053/oz, ending the month 1% lower, departing from their typical seasonal strength. This pullback followed a strong finish to the previous year, with global gold ETF outflows totalling 51t and a decrease in COMEX futures net longs (-206t) contributing to the decline. Additionally, higher Treasury yields and a stronger US dollar, driven by robust US economic data and dashed hopes of early monetary policy cuts, added to the pressure on gold prices.

The prospect of a March Fed rate cut was dampened by dissenting voices within the Fed and positive economic indicators, along with a hawkish turn from the ECB. While falling rates generally benefit gold, historical data suggests that the first Fed cut after a hiking cycle may only lead to short-term rallies if accompanied by significant economic or equity market corrections.

Several factors suggest that the path to target inflation and a soft landing for the economy may face challenges. Financial conditions have eased considerably in recent months, indicating continued economic comfort in the short term. Labor costs remain elevated, driven by strong small business compensation plans, and rents are forecasted to contribute significantly to core inflation. Additionally, tensions in the Red Sea are impacting freight costs, potentially leading to supply chain pressures like those experienced in 2022. However, higher bond yields could also result in equity market volatility, given the elevated valuations in the stock market. Moreover, upcoming elections and geopolitical uncertainties are expected to keep investor sentiment cautious, potentially supporting demand for gold as a safe haven asset.

WTIS

In the crude oil market, it’s worth noting that prices have fallen below the US$80/bbl threshold, a development that has taken us somewhat by surprise. This drop comes despite the near-term upside risks for refined fuels and refining margins, and consequently crude prices, due to several factors. These include the extreme cold weather in the US, Ukrainian drone attacks on Russian refinery capacity, Houthi assaults on vessels in the Red Sea, and escalating tensions that could potentially draw Iran into direct conflict with the US.

The latter two risks continue to exert significant influence on crude markets in the short term, given the strategic importance of the Suez Canal and the Red Sea for crude supply routes. In 2022, the Bab al-Mandab Strait experienced a surge in the number of tankers transiting through, as Russian crude and products redirected south to Asia due to EU sanctions, while Middle Eastern crude flowed northward through the Suez Canal and Sumed pipeline to compensate for the lost supply. However, recent data reveals a significant downturn in transit calls through both the Bab al-Mandab Strait and the Suez Canal in January 2024, signalling potential disruptions in traffic flow.

While IMF Port Watch data does not provide detailed distinctions between tanker types, insights from Kpler indicate that oil tanker transits through the Red Sea have declined, with even steeper drops observed for LPG and LNG shipments. This suggests that the impact of disruptions has been more pronounced in fuels rather than crude markets. However, prolonged disruptions may lead to more structural blockages, escalating costs, and a greater impact on crude and liquid inventories.

Considering these developments, we maintain a cautiously optimistic near-term outlook for refining margins and fuels, which in turn supports crude oil prices.

Agriculture commodities

Throughout the rest of 2024, global food commodity prices are expected to see relief after enduring three years of record highs, attributed to factors such as conflict, adverse weather conditions, and escalating energy and input costs. Despite agricultural commodity prices trending lower compared to the previous two years, forecasts indicate continued positive farm margins across key agricultural sectors for the year ahead.

However, caution is advised due to ongoing global economic challenges, particularly concerning China’s economy and import volumes, as well as the impact of geopolitical issues on freight. Additionally, Australia’s farm sector and agribusiness industries are likely to face persistent challenges stemming from a tight labour market.

Despite these concerns, major agricultural sectors are entering 2024 with a sense of confidence, notably after El Nino’s impact was less severe than initially feared. Grain farmers are anticipated to plan more optimistically for farm inputs and upcoming planting periods for winter crops like wheat, barley, and canola. However, uncertainties remain prevalent in other key agri-commodity markets, with weather-related disruptions and potential export restrictions posing challenges, especially in regions heavily reliant on wheat production.

Sector	12 Month Forecast	Economic and Political Predictions
AUD	65c-73c	In the coming weeks and the next 3-6 months, the outlook for the Australian Dollar against the US Dollar shows a mixed picture. Short-term forecasts suggest relative stability, with a slight dip to around 0.6548 in three months and a modest increase to about 0.6563 in six months. However, looking further ahead, there’s optimism regarding AUD against the USD. Westpac foresees a rise to 0.70c by the end of 2024, while NAB predicts an even more substantial increase to 0.73c.
Gold	BUY $US1800-/oz- $US2200/oz	The path of gold prices is expected to be heavily influenced by Fed interest rate adjustments and the reduction in U.S. real yields. Short-term projections indicate a minor decrease in gold prices, followed by a rebound and the possibility of reaching new highs later in the year. Forecasts suggest a potential peak of $2,300/oz by 2025.
Commodities	Copper BUY Oil HOLD	We are constructive on commodities as key markets such as oil and copper remain finely balanced and are supported by limited inventories, producer discipline and/or supply shortfalls, with demand potentially benefitting from a China recovery or stimulus.
Property	BUY	Real estate values have been repriced throughout the year, due to the high interest rate environment and the macroeconomic outlook. Vacancies continue moderating but remain well below historical long-term averages across many property types.
Australian Equities	Accumulate	Upon reviewing the valuations of several S&P/ASX 200 Index (ASX: XJO) shares, it appears that many of them have experienced significant recoveries from their lows in 2022 or 2023. Consequently, they no longer appear to offer the same level of value as they did previously.
Bonds	Begin to increase duration.	As interest rates stand at or near peak for most economies and inflation is likely to decline, albeit gradually and with volatility, some central banks are likely to start cutting interest rates, a process which has already started already in parts of the developing world.
Cash Rates	RBA to start reducing rates 4.00%	Cash has appeal as a means of diversification and as a complement to the potential attractions of fixed income markets, and we maintain a moderately constructive view currently.