US Treasury Secretary Janet Yellen on January 6 pronounced the US economy had achieved the feat sought by investors worldwide whereby policymakers rein in excessive inflation without triggering a leap in unemployment or a recession.
The former Federal Reserve chair’s statement on CNN that “what we’re seeing now I think we can describe as a soft landing” inadvertently affirmed the rallies on financial markets over the fourth quarter.
Just about everything surged after US inflation slowed – pivotal readings included one that showed US consumer prices rose just 0.1 per cent in November. Such numbers fanned expectations the Fed would cut rates in 2024. At the same time, the jobless rate stayed near 50-year lows as the US economy is humming – expanding at an annualised pace of 4.9 per cent in the third quarter. In what might already rank as the understatement of the year, Yellen’s “hope is that (such good news) will continue.”
What are the biggest risks to such hopes? On the inflation score, one worry must be the war in the Middle East. As the fighting has spread from Israel to the Arabian Sea, Iran, Iraq, Lebanon, the Red Sea, Syria and Yemen and the Islamic State has reemerged, perhaps it’s more accurate to say the war has widened. It’s only its intensity and duration of the widening that remains unclear.
The biggest inflationary aspect of the conflict so far are that attacks since mid-November on shipping in the Red Sea by Yemen-based Houthi Shia militants in reaction to Israel’s campaign in Gaza. Ships are forced to head around South Africa, which adds to costs in a way that threatens the global economy. The attacks since Friday on Youthi targets by the US-led force might end the ceasefire between the Houthi and a Saudi-led, Western-backed Sunni coalition that fought in the civil war between 2015 and 2022 that the Houthi won. During that conflict, the Houthi attacked Saudi Arabia’s oil heartland with drones and missiles and could repeat the feat.
Risks from the masses
Another threat to inflation seems to be the return of the Phillips Curve, which purports to show an inverse relationship between unemployment and wages growth and thus inflation. While investors celebrate disinflation, the masses only see that everything costs more. They want higher wages to compensate. US workers are now securing gains ahead of inflation – average hourly earnings of private sector (non-farm) employees rose 4.1 per cent in 2023 compared with an increase of 3.4 per cent in consumer prices. A jobless rate at only 3.7 per cent in December means US workers have the bargaining power to ignite the wages-prices spiral that investors and policymakers dread.
This year is unusual for the more than 40 elections to be held around the world. The riskiest for investors were the Taiwan presidential election held on Saturday and the US election in November. In Taiwan, the victory for the pro-independence candidate Vice President Lai Ching-te of the pro-sovereignty Democratic Progressive Party could prompt Chinese aggression towards the island. Yet, knowing that was the likely result, the US poll is Eurasia Group president Ian Bremmer’s No 1 global risk for 2024. “The only certainty is continued damage to America’s social fabric, political institutions and international standing,” Bremmer said last week when outlining his top 10 global risks for 2024.
Investors might see few risks for asset prices from the potential rematch between Donald Trump and Joe Biden. But as Nobel Laureate for economics Paul Krugman warned last week the campaign could jeopardise the Fed’s expected rate cuts. “Trump and his supporters will scream that the coming rate cuts are part of a deep-state conspiracy to re-elect President Biden” and the Fed might keep rates “too high for too long” in response, Krugman said. The US economy – and thus stocks – could suffer. The Fed might need to cut rates, not as a consequence of taming inflation, but to protect the economy.
The pandemic dominated the 2020 electoral contest between Biden and Trump. One lingering investment risk from the virus comes from the popularity of working from home. That trend, past overbuilding and higher interest rates are troubling commercial property worldwide. As of the fourth quarter, 19.6 per cent of office space in major US cities wasn’t leased, the highest percentage since Moody’s Analytics began compiling such data in 1979, The Wall Street Journal reports. The danger for investors is that mid-sized US banks are the most exposed to any crunch in US commercial property.
Many worry that another menace is that the booms in private equity and shadow banking known as private credit are brewing crises. Private-asset managers tend to borrow to buy assets. If higher rates torpedo any of these firms, the global financial system might shake. Private credit is generally extended to borrowers that banks shun. A burst of defaults could trouble these non-bank lenders with wider consequences.
It’s hard to reconcile such risks with surging global share markets and the S&P 500 Index close to a record high. But here we are at the start of what’s shaping to be a turbulent year.
To be sure, some investment risks for 2024 have already dissipated and so could many of these risks. The biggest relief so far is that US Congressional leaders have agreed on a US$1.6 trillion level for Washington’s spending for 2024, a bipartisan effort that is expected to avert a government shutdown.
But that deal’s not finalised and there’s plenty more to worry than the risks discussed here. These threats include Ukraine-war reverberations, a German recession reigniting the eurozone crisis, a Chinese economic slump and a snapping of the warped co-dependency of stocks and interest rates (that overlooks economic conditions and political risks).
It will be interesting to see how credible Yellen’s declaration that the US economy has achieved a soft landing looks at year end. And to know what became of the asset rally fanned by such hopes.