Three years of pandemic and two years of frantic interest rate hikes have brought unprecedented turbulence to the world economy. With the controlled momentum of rising prices and the cessation of rate hikes by central banks in the United States and Europe, the macro situation is somewhat relieved, and asset prices are rapidly rebounding. Against this backdrop, what path will the world economy take in 2024? It is believed that "change" will be the prevailing theme. Six uncertainties will lead the economy, dominate the market, and alter our lives. This implies the restart of the economic cycle, bringing both opportunities and concealed risks.

Uncertainty One: When and How Will the Fed Cut Interest Rates

The long-standing inflation issue in the United States is approaching control. While the core PCE is approaching the 3% threshold, and the core CPI, excluding rent, has already reached the 2% policy target, Federal Reserve Chairman Powell has begun to discuss the possibility of rate cuts. This has led to a rare Christmas rally in the U.S. bond and stock markets. However, there is a significant divergence between market traders and Fed policymakers on how to cut interest rates. The market believes that after stable prices and a decline in growth, interest rates will quickly fall. Interest rate futures market speculates that rate cuts will begin in March 2024, with six cuts of 150 basis points throughout the year. Fed officials are issuing warnings, stating that rate cuts may not come as quickly as expected. The FOMC dot plot predicts rate cuts to begin after mid-2024, with three cuts of 75 basis points.

The core of the market-Fed divergence lies in how to view the job market and financial risks. The author believes that the U.S. job market is following an unprecedented trajectory, with the rise in unemployment and the decline in wage growth differing from previous paths. This uncertainty makes the inflection point of interest rates highly uncertain. The current best policy option for the Fed is to remain unchanged until financial tightening or economic recession forces a policy adjustment. It is expected that the Fed will start cutting rates around mid-year, with three cuts throughout the year.

Uncertainty Two: Will Europe Fall into Economic Recession

The economic situation in Europe is much worse than in the United States. After the end of the pandemic, the European economy experienced a significant rebound, and prices fell sharply. However, the job market, the mother of recovery, is not thriving, and demand is not robust. Soaring living costs have led to demands for higher wages, and labor strikes are frequent. Wage pressures, combined with Europe's traditionally high sensitivity to malignant inflation, make the European Central Bank more assertive, refusing to discuss the issue of rate reversal. The Eurozone's manufacturing PMI has been below the boom-bust line for 17 consecutive months, and the service sector PMI has also fallen below the boom-bust line, indicating that the European economy may have entered an economic recession. With high interest rates, the impact on highly indebted countries and businesses continues to ferment, and commercial real estate issues are serious.

EU countries are entering a period of fiscal contraction in 2024, with only monetary policy having room to maneuver. The timing of when the European Central Bank can reverse its policy stance is crucial, and Germany's attitude is paramount. Germany's largest industry, the high-wage automobile sector, is rapidly losing global market share. Budget crises and election timing increase the possibility of Germany loosening its stance. Let's see if the European Central Bank will be the first to cut interest rates. It is expected that Europe will fall into recession, and the European Central Bank will start cutting interest rates around mid-year.

Uncertainty Three: How Will the Bank of Japan Adjust the Yield Curve

The yen depreciated against the dollar by 8% in 2023, dropping to below 150, and surprisingly, Western countries, led by the United States, did not express opposition. The only reasonable explanation for this is to create space for Japanese banks to prepare for a policy shift in adjusting the yield curve. After more than a decade of implementing quantitative easing policies, the Bank of Japan intervened in the bond market in 2016, artificially keeping the 10-year government bond yield below zero. After the United States and Europe entered a rate hike cycle, Japan's zero-interest-rate policy became increasingly unreasonable, attracting a large number of short positions in government bonds. Due to the huge interest rate difference between the United States and Japan, arbitrage positions were almost risk-free, becoming a "reservoir" in the financial market. The large scale of short positions in Japanese bonds, if mishandled, could bring about a global financial catastrophe. Therefore, the Bank of Japan, through unexpected policy maneuvers, increased exchange rate volatility, raised short-selling costs, and hoped that speculators would retreat.

Now, short positions have significantly decreased, and the Japanese economy has emerged from three decades of stagnation. Inflation expectations and wage growth expectations are returning to normal. It is believed that the time for adjusting the yield curve management policy is getting closer. The direction of the central bank's policy adjustment is clear, but the timing remains elusive. It is expected that the Bank of Japan will start adjusting the yield curve management policy in March and complete it by the end of the summer.

Uncertainty Four: The Duel of Two Old Men in the U.S. Election

The U.S. presidential election will take place in November. Despite the heated primaries of the Republican and Democratic parties, it is likely to be a contest between two octogenarians. Traditionally, the Republican Party seeks prudent fiscal policies, while the Democratic Party focuses on a large budget. However, since the Trump era, the positions of the two parties on deficit finance have converged significantly. The congressional debt ceiling dispute has also evolved into a party-political tool, with neither side seeking genuine control over government spending. The Biden administration's inflation reduction bill, with a deficit reaching 8.3% of GDP, is unprecedented in peacetime, especially when the economy does not need further stimulus. The interest payments on the government's massive debt have already exceeded the defense budget, but the election debate focuses on non-economic issues such as immigration.

If Trump is elected, the Fed's current policy may face challenges, and Powell's reappointment may be difficult. This may force the United States to adjust its extremely loose policies since 2008, and the process of deglobalization may further accelerate. Commitments to addressing climate change may even be scaled back. Despite robust employment in the United States, Biden's approval ratings are low, and the gap between the two candidates may be as close as in the last election.

Uncertainty Five: Will the Supply Chain Crisis Resurface

The El Niño phenomenon is spreading in the Americas, with the southern United States experiencing the largest drought on record, affecting agriculture and livestock. The Amazon basin is facing its largest drought on record, impacting agricultural production and putting millions of species at risk of extinction. Drought has caused a significant drop in the water level of the Panama Canal, reducing the number of ships passing through to 40% of normal, substantially impacting the Asia-East Coast of America route. Meanwhile, Houthi attacks on merchant ships in the Gulf of Aden have forced major shipping companies to divert through the Cape of Good Hope, increasing costs and extending transit times. The appeal for military escort in the Asia-Europe route has not received significant responses from many countries, and the Asia-Europe route has been significantly affected. Container rents have risen sharply, and the supply chain risks caused by the pandemic seem to be making a comeback.

The current supply chain risks are still in the early stages of development. The time to resolve the blockages in the two major canals needs further observation. However, supply chain security issues are bound to accelerate the progress of deglobalization and become the underlying logic for the resurgence of inflation.

Uncertainty Six: How Will ChatGPT Change the World

ChatGPT emerged a year ago, causing a significant impact on the world and triggering an unprecedented flow of funds into the AI industry. Applications of large-scale AI models have sprung up like mushrooms, showing remarkable capabilities in tasks such as student essays and code writing. However, breakthroughs sufficient to disrupt industries or products have not yet been seen, and new profit models seem to be still beneath the surface. Considerations for data security and intellectual property have also slowed down ChatGPT's rapid progress. However, almost all major tech companies are incorporating AI elements, adjusting their strategies and architectures, preparing for upgrades to existing products.

2024 may be a turning point for ChatGPT. With the integration of Copilot into Windows (likely by mid-year), AI will transition from being a plaything of tech companies to being commonplace in households and small businesses. Generative AI landing on PCs and smartphones could usher in an era of democratization of artificial intelligence.

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