Happy New Year! May you live in interesting times
Leitmotif 1: Trend inflation’s path
The High Priestess Tarot card, signifies intuitive, unconscious, inner voice
December closed 2023 with significant challenges to my views on inflation and central bank policies, but also (worryingly) reinforced my fears that Global entropy might tip into a Complexity cascade of geopolitical disorder unseen in generations. Unexpectedly rapid declines in inflation across economies amid accelerating deterioration in international relations suggest that 2024 likely will fulfill the apocryphal Chinese curse, “May you live in interesting times.”
Larger-than-expected falls in core inflation and surveyed inflation expectations challenge my expectations for sustained Being is believing effects to make Inflation’s final mile back to target both slower and more challenging than markets or central banks expect. Yet I see the Fed’s confused and mixed dovish turn as a greater challenge to the outlook. Their pivot mimics with worrying similarities the two other times in the last two decades I’ve gotten the Fed wrong. Their forward guidance appears to eschew prudent risk management and stake their credibility on an all-in bet on forecasts that reflect inflexible views on US potential growth, neutral rates and the inflation generation process. More troubling, by abandoning “FAIT” – flexible average inflation targeting – they may be tacitly signalling greater inflation accommodation.
Fed policy errors, via rates volatility and higher term premia, would accentuate fiscal policy challenges nearly everywhere. Into that melee, jumps Argentina’s new president, Javier Milei, who is initiating a fascinating fiscal policy experiment – and relative value opportunity – for 2024, particularly in comparison with Brazil. But 2024 is also a year of consequential elections around the world – the EU, India, Indonesia, Mexico, South Africa, Taiwan, the UK, and of course the US – just as both Argentina and the Netherlands have demonstrated that the Politics of Rage is alive and kicking. Yet, against the backdrop of all these monetary, fiscal and political risks, both currency and rates markets price both widespread convergence and a narrowing range of potential outcomes.
However, the most significant and worrying development in the closing weeks of 2023 has been the rapid deterioration in geopolitical stability. The sharp acceleration in Global entropy since I wrote Global entropy: Enter the dragons reinforces my worry that the greatest threat to market pricing comes from a Complexity cascade into uncharted geopolitical volatility, with potential for radical realignment and economic disruption. As such, I am hard at work on the promised Part II of Enter the dragons, outlining hedging strategies for both long-only and leveraged portfolios (apologies, this is to blame for the unusually long break in publications).
But given the dizzying changes to the outlook in just the last month I though an interim update on my views made sense while I finish the analysis on Part II. I am focused on eight leitmotifs that I expect to define markets in 2024 (sorry, Themes, is already a reserved word here at Thematic Markets!). As each requires some explanation and analysis, I am going to break them up and release them over the next two weeks, beginning with the first, an update on trend inflation’s path, today.