Bank of Japan Stays on Hold, UK Public Finances in Focus

CMC

Central Bank

Economic

Forex

Summary:

Today's Bank of Japan decision didn't offer up any surprises with the central bank keeping monetary policy unchanged against a backdrop…

European markets saw a cautious but broadly positive start to the week, despite weakness in basic resources which served to weigh on the FTSE100.

US markets picked up where they left off on Friday with new record highs for the Dow, S&P500 and Nasdaq 100 although we did see a loss of momentum heading into the close, as US yields rebounded off their lows of the day.

The tentative nature of yesterday's gains appears to be being driven by a degree of caution ahead of some key risk events over the next couple of weeks, starting today with the latest Bank of Japan policy decision. This is set to be followed by the European Central Bank on Thursday, and then the Fed and Bank of England next week.

For most of this month central banks have been keen to reset the policy narrative when it comes to the timing of rate cuts which had markets pricing in the prospect of an early move.

While US markets have managed to shrug off the prospect of a delay to possible rate cuts, markets in Europe have struggled with the concept probably due to the weakness of the underlying economy relative to how the US economy has been performing. There is a sense that the ECB is over prioritising the battle against inflation which is coming down rapidly and not seeing the damage that is being done to the wider economy by keeping rates higher than they need to be.

Today's Bank of Japan decision didn't offer up any surprises with the central bank keeping monetary policy unchanged against a backdrop that has seen market expectations of rate cuts from other central banks increase markedly since the last Fed meeting. This shift in expectations has helped to ease some of the pressure on the BoJ to look at tightening policy itself to slow the decline of its own currency.

The bank also cut its inflation forecast for this year from 2.8% to 2.4%, while nudging its 2025 forecast slightly higher to 1.8%.

Asia markets have seen a more upbeat session on reports that Chinese authorities are looking at a package of stimulus measures to help stabilise the stock market, which could come as soon as next week.

Despite this more positive tone European markets look set to open only modestly firmer, with the only economic data of note due today being the latest public finance data from the UK for December.

As far as UK government borrowing is concerned rising interest costs at the beginning of Q4 served to exert upward pressure on the headline numbers, pushing borrowing up to £16bn in October, the second highest October number since 1993.

Since those October peaks, gilt yields have declined sharply, along with headline inflation, helping to ease borrowing costs in the mortgage market. This weakness has also come as a welcome relief to the Chancellor of the Exchequer, after UK 10-year yields fell to a low of 3.44%, down from a peak of 4.73% in October.

These lower interest costs are likely to see December borrowing slow to £14.1bn, while January could see a surplus as end of year tax payments boost the numbers.

EUR/USD – currently has support at the 200-day SMA at 1.0840. A break below here and the 1.0800 level targets the 1.0720 area. Currently capped at the 50-day SMA with main resistance up at 1.1000.

GBP/USD – remains resilient with support just above the 50-day SMA and 1.2590 area. We need to get above 1.2800 to maintain upside momentum. Also have support at the 200-day SMA at 1.2550.

EUR/GBP – continues to find support at the 0.8540/50 level which has held over the last 2-months. A fall through here could see further falls towards the 0.8520 area. We still have resistance at the 0.8620/25 area and the highs last week.

USD/JPY – has retreated modestly from the 148.50 area but remains on course for the 150.00 level. Pullbacks likely to find support at the 146.25 level cloud support as well as the 50-day SMA.

To stay updated on all economic events of today, please check out our Economic calendar

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Samantha Luan

Central Bank

Economic

Forex

Yen weakened momentarily after BoJ left monetary policy unchanged as widely expected, but swiftly regained stability. This quick recovery underscores the market's assessment that the conditions for a BoJ rate hike in April remain intact. This viewpoint is bolstered by unchanged CPI core-core forecast, which holds steady at 1.9% for the upcoming two fiscal years. However, BoJ refrained from offering any immediate signals for such a policy shift. The decision on whether to raise interest rates will depend heavily on the outcomes of the Spring wages negotiations, especially in terms of the breadth of wage growth. Given these circumstances, Yen still faces potential downside risks in the near term.

Meanwhile, Dollar softened mildly in Asian session, correlating with recovery in Hong Kong stock markets. After enduring a prolonged downturn, HSI is showing early signs of stabilization. News that China is mulling a USD 278B stock market rescue package is lifting sentiment mildly. However, it's still too soon to declare a definitive reversal of the down trend. Risk-off sentiment in Hong Kong and China would continue to support the greenback, and pressure commodity currencies.

The broader currency market remains relatively inactive, with most major pairs and crosses are stuck inside yesterday's range. Dollar is the worst performer, followed by Canadian and then Yen. Aussie and Kiwi are the stronger ones with Swiss Franc. Euro and Sterling are mixed. The market is likely to experience a lull in volatility today, given the light economic calendar. However, activity is expected to pick up with tomorrow's release of New Zealand's CPI and global PMI data, which could trigger more pronounced movements.

Technically, EUR/CAD is extending the consolidation from 1.4547 at this point. Further decline is in favor as long as 1.4763 minor resistance holds. Below 1.4547 will resume the fall from 1.5041. However, as price actions from 1.5111 are seen as a sideway pattern only, strong support should emerge around 1.4155 to bring rebound. Meanwhile, break of 1.4763 will bring retest of 1.5041 resistance instead. Given that both BoC (Wednesday) and ECB (Thursday) will announce interest rate decision this week, EUR/CAD is a pair that's worth some attention. Yen Steady After Brief Ripples from BoJ, Dollar Softens Mildly_1

Yen Steady After Brief Ripples from BoJ, Dollar Softens Mildly_1

In Asia, at the time of writing, Nikkei is up 0.09%. Hong Kong HSI is up 2.92%. China Shanghai SSE is up 0.36%. Singapore Strait Times is up 0.03%. Japan 10-year JGB yield is down -0.0089 at 0.645. Overnight, DOW rose 0.36%. S&P 500 rose 0.22%. NASDAQ rose 0.32%. 10-year yield fell -0.052 to 4.094.

BoJ holds steady, with CPI core-core projected at 1.9% in next two fiscal years

BoJ let monetary policy unchanged as widely expected. The forecast for fiscal 2024 CPI core was downgraded, whereas fiscal 2025 CPI core forecast saw a slight upgrade. Notably, CPI core-core forecasts for fiscal 2024 and 2025 were left unchanged at 1.9%, indicating a steady path towards achieving Japan's 2% inflation target sustainably.

Under Yield Curve Control, BoJ kept short-term policy interest rate unchanged at -0.1%. Additionally, target for 10-year JGB yield remains around 0%, with an allowance for fluctuation below 1.0% upper bound. These decisions were made by unanimous vote.

BoJ noted, "Consumer inflation is likely to increase gradually toward the BoJ's target as the output gap turns positive, and as medium- to long-term inflation expectations and wage growth heighten." The central bank also acknowledged the growing "likelihood" of realizing this outlook, albeit with an emphasis on the continued "high uncertainties" surrounding future developments.

In the median economic projections:

Fiscal 2023 GDP growth at 1.8% (down from October's 2.0%).

Fiscal 2024 GDP growth at 1.2% (up from 1.0%).

Fiscal 2025 GDP growth at 1.0% (unchanged).

On the inflation front:

Fiscal 2023 CPI core at 2.8% (unchanged).

Fiscal 2024 CPI core at 2.4% (down from 2.8%).

Fiscal 2025 CPI core at 1.8% (up from 1.7%).

Fiscal 2023 CPI core-core at 3.8% (unchanged).

Fiscal 2024 CPI core-core at 1.9% (unchanged).

Fiscal 2025 CPI core-core at 1.9% (unchanged).

Australia's NAB business confidence rises to -1 amidst slowing price growth

Australia NAB Business Confidence fell rose from -8 to -1 in December. However, Business Conditions fell from 9 to 7. The decline was observed across several key areas: Trading conditions dropped from 13 to 10, while Employment conditions also decreased slightly from 8 to 7. Profitability conditions remained steady at 6.

NAB Chief Economist Alan Oster noted that "confidence and conditions are softest in manufacturing, retail and wholesale," attributing this to consumers cutting back on spending over time. Although there was a pickup in confidence within the retail sector in December, Oster expressed caution, stating that "it remains to be seen if this will be maintained."

Another significant development was the sharp decline in price and cost growth. Labor cost growth eased to 1.8% in quarterly equivalent terms, down from 2.3%. Purchase cost growth also declined from 2.5% to 1.6%. Overall price growth slowed from 1.2% to 0.9%, with notable decrease in retail price growth from 1.8% to 0.6%.

Oster highlighted the significance of this decline in retail price growth, attributing it in part to the sales periods around Black Friday and Christmas. He remarked, "The marked fall in retail price growth in December… is nonetheless an encouraging sign that inflation may have eased at the end of the quarter."

New Zealand BNZ services falls to 48.8, back in contraction

New Zealand BusinessNZ Performance of Services Index fell from 51.1 to 48.8 in December, back into contraction territory. This downturn also brings the index below long-term average of 53.4. The increase in negative sentiment is evident, with the proportion of negative comments rising from 54.0% to 58.7%. The primary concerns expressed by businesses revolve around seasonal factors, increasing costs of living, and an overall economic slowdown.

Breaking down the PSI, several key components showed declines. Activity and sales dropped from 48.7 to 47.1, employment fell from 50.6 to 47.5, and new orders/business dipped from 52.2 to 51.2. Additionally, stocks and inventories decreased from 55.0 to 51.5, while supplier deliveries also saw a reduction from 52.8 to 50.5.

Stephen Toplis, BNZ's Head of Research noted that the softening in PSI, combined with the previously reported weakness in Performance of Manufacturing Index, paints a concerning picture for New Zealand's near-term economic growth and employment. While tourism has been a critical driver for the services sector and is expected to continue supporting the economy, Toplis emphasized that it cannot solely bear the burden of economic revitalization.

Looking ahead

UK public sector net borrowing, Eurozone consumer, and Canada new housing prices are the only features in the calendar today.

USD/JPY Daily Outlook

Intraday bias in USD/JPY remains neutral for the moment. Consolidation from 148.79 temporary top could extend further, and deeper retreat cannot be ruled out. But further rally is expected as long as 145.97 resistance turned support holds. Corrective fall from 151.89 should have completed at 140.25 already. Break of 148.79 will resume the rise from there for retesting 151.89/93 key resistance zone. Yen Steady After Brief Ripples from BoJ, Dollar Softens Mildly_3

Yen Steady After Brief Ripples from BoJ, Dollar Softens Mildly_3

In the bigger picture, stronger than expected rebound from 140.25 dampened the original bearish review. Strong support from 55 W EMA (now at 141.89) is also a medium term bullish sign. Fall from 151.89 could be a correction to rise from 127.20 only. Decisive break of 151.89/93 will confirm resumption of long term up trend. This will now be the favored case as long as 140.25 support holds. Yen Steady After Brief Ripples from BoJ, Dollar Softens Mildly_4

Yen Steady After Brief Ripples from BoJ, Dollar Softens Mildly_4

Source: ActionForex

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SAXO

Stocks

Key earnings week ahead

The Q4 earnings season has been dominated so far by US financials, but this week the earnings season broadens out to industrials, technology and health care. The list below highlights the 30 largest market cap companies reporting earnings this week.

Tuesday: Verizon Communications, Netflix, Texas Instruments, Intuitive Surgical, Johnson & Johnson, Procter & Gamble, General Electric, RTX, Lockheed Martin

Wednesday: SAP, ASML, Elevance Health, Tesla, IBM, ServiceNow, Lam Research, Abbott Laboratories, AT&T, Progressive

Thursday: Union Pacific, T-Mobile US, Visa, LVMH, Intel, Comcast, Blackstone, NextEra Energy, Marsh & McLennan

Friday: Christian Dior, American Express

Based on retail investor exposure the three most important earnings releases this week will be Netflix, Tesla, and ASML setting the sentiment for US equities during the week. Next week the earnings season gets into its most important week with earnings releases from the largest US technology companies.

Earnings preview: Netflix, Tesla, and ASML

Netflix: Full speed on margin expansion and growth

Reports FY23 Q4 earnings tomorrow (aft-mkt). Analysts expect revenue growth of 10.9% y/y and EPS growth of 142% y/y due to compounding effects of momentum in advertising revenue, higher subscriber growth and subscription price increases.

Given the momentum in Netflix business our view is that the company is poised to exceed estimates for Q4 boosting sentiment in technology stocks this week.

Netflix is on track to deliver $6bn in free cash flow in FY24 which equates to a free cash flow yield of around 3%.

Key focus for investors is the outlook for revenue growth in FY24 which is estimated at 13.8% y/y. Earnings Watch: Can Tesla Convince the Market About Growth?_1

Earnings Watch: Can Tesla Convince the Market About Growth?_1

Tesla: Growth delusions and gross margin fight

Reports FY23 Q3 earnings Wednesday (aft-mkt). Analysts expect revenue growth of 6.3% y/y, the lowest since the -4.9% y/y growth in FY20 Q2 during the pandemic. EPS is expected at $0.53 down 44% y/y as competition has increased and especially on pricing.

BYD has overtaken Tesla on deliveries becoming the world’s largest battery EV maker and is also beginning to make inroads in the higher priced segment that Tesla has dominated.

Tesla has previously promised investors 50% annualised growth for 10 years, but with revenue growth expected in FY23 at 19.8% and 20.7% in FY24, the question is whether Tesla will soon be forced to abandon its growth targets.

Tesla must convince investors that growth will resume from the current low levels to levels above +20% growth while preserving gross margin which has slipped below 20% down from 25.6% in FY22.

Lower prices on lithium carbonate is helping on sustaining gross margin while cutting prices to keep up with Chinese competitors, but any further flip in gross margin outlook could become toxic for Tesla’s stock price.

ASML: Surfing the boom in AI investments

Reports FY23 Q4 earnings on Wednesday (European pre-mkt). Analysts expect revenue growth of 7.6% y/y and EPS of €4.80 up 5% y/y.

Key focus for investors is the FY24 revenue growth outlook. Analysts are quite bearish with only 0.4% revenue growth projected setting a low bar for the Dutch semiconductor equipment maker. However, the sluggish revenue growth projections come on the back on a weak ASML guidance in October of unchanged revenue in 2024.

Looking beyond 2024 analysts expect revenue growth to increase to 22.3% in FY25 and EBITDA hitting €13.3bn.

The key driver for ASML beyond 2024 is the CapEx signals from TSMC, the world's largest foundry chip maker, indicating strong focus on 3 and 2 nanometer chips which will boost demand for ASML’s extreme ultraviolet machines which the company controls with a 100% market share.

Q4 earnings are off to a good start as technology earnings soar

The Q4 earnings have so far delivered a net positive surprise on both revenue and earnings with especially financials and consumer discretionary companies delivering the biggest positive surprises. The message from US banks also leaned on the positive side for 2024 although acknowledging the key risks to the economy. JPMorgan Chase is expected to expand the business this year and the net charge-offs (bad debt written off) in percentage of loans are still running at very low levels approaching the average level from the years before the pandemic.

There have been a lot of talk about the rising technology stocks pushing equities to new all-time highs. Some argue that it is crazy and animal spirits are too wild and not backed by reality, but in fact the reality is actually that operating income (EBITDA) has massively rebounded for Nasdaq 100 companies in the previous two fiscal quarters supporting the ongoing rally in technology stocks. Earnings Watch: Can Tesla Convince the Market About Growth?_3

Earnings Watch: Can Tesla Convince the Market About Growth?_3

Earnings Watch: Can Tesla Convince the Market About Growth?_4

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Zi Cheng

Traders' Opinions

Economic

The Bank of Japan, in its two-day meeting, opted to keep its monetary policy settings unchanged and made adjustments to its economic projections. However, it did not provide clear indications regarding the potential timing for the conclusion of the negative interest rate policy. This development led to a weakening of the yen.

As of Tuesday, the BOJ maintained the short-term rate at -0.1% and left the yield curve control parameters unchanged, as stated in their official announcement.

In its quarterly outlook report, the bank revised down its inflation forecast for the fiscal year starting in April, reducing it from 2.8% to 2.4%. This adjustment implies that the inflation rate is expected to remain above the 2% target for an extended period, a trend observed since April 2022.

The BOJ's policy decision, as anticipated by Bloomberg's surveyed BOJ watchers, unfolded as expected. Given the recent seismic event on New Year’s Day and a deepening funding scandal within Prime Minister Fumio Kishida’s ruling party, the timing for Japan's first rate hike since 2007 seemed inappropriate. By maintaining the status quo, the BOJ continues to stand out globally in terms of policy, diverging from the Federal Reserve and European Central Bank, which are hinting at potential rate cuts later this year.

Following the announcement, the yen experienced a decline against the dollar, briefly reaching 148.55 per dollar as market participants factored in the likelihood of the negative rate persisting for an extended period.

Despite the decision to hold rates steady, it is unlikely to alter the prevailing sentiment among economists, who still anticipate a rate hike from the BOJ at some point this year. The bank expressed increasing confidence in gradually achieving its price target, signaling its commitment to the path leading to a rate hike.

Economists surveyed suggest that April is the most probable timing for the cessation of the negative rate, allowing the central bank to evaluate the outcomes of annual pay negotiations. Higher wages are considered crucial for establishing a positive cycle of increasing prices and wages, contributing to economic growth.

Ahead of the Tuesday meeting, sources revealed that BOJ officials believed their price projections, around 2% or higher, justified ending the negative rate. Their current focus is on whether the outlook's certainty will increase sufficiently.

Governor Kazuo Ueda is scheduled to address reporters in the afternoon, likely from 3:30 p.m. Given the recent yen depreciation, Ueda is expected to avoid sounding too dovish, as a yen around 150 keeps import costs high and adds to inflationary pressures, posing a potential threat to already weakened consumer spending. Faced with rising living costs, households are growing impatient with the prolonged monetary easing, especially as a key price measure stays above the BOJ’s 2% target.

To stay updated on all economic events of today, please check out our Economic calendar

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Devin

Economic

Commodity

Gold had a spectacular run from 2001 to 2011, rallying over 600% from $260 to $1,900 per ounce. Its performance since has been more modest, reaching $2,080 in July 2020, a level it struggled to maintain until it briefly broke out to a new high in December 2023.

Gold's rally from 2001 to 2011 coincided with stable core inflation of around 2%. By contrast, from 2021 to 2023 when the U.S. economy experienced the steepest surge in inflation since the late 1970s and early 1980s, gold prices barely budged. So, if not inflation, what really drives gold? And what should investors expect in 2024 and 2025?

Gold is driven by both demand and supply factors. There are a few demand-side factors that drive the prices of gold on a day-to-day basis, and over the long term. They are the value of the U.S. dollar against foreign currencies, and the evolution of expectations for future Federal Reserve (Fed) policy. An additional demand factor is the buying of gold by central banks, which appears to move prices over the longer term. Finally, gold mining supply also has a strong influence on the price of gold, but one that is typically measured year to year rather than day to day.

Central Banks as Buyers of Gold

Gold is the world's oldest consistently used currency with close to 5,000 years of history. Admittedly, most people in 2024 might not think of gold as being a currency at all. It's not in daily use, like in buying coffee, cars or homes. That said, the world's central banks clearly view gold as a currency – or at least a reserve asset – and since the global financial crisis (GFC), they have been buying more and more of it (Figure 1). Many years of near-zero or even negative interest rates set by central banks combined with quantitative easing (QE) and various sanctions regimes led many central banks to favor gold over central-bank-issued currencies. Neither the recent uptrend in rates nor the reversal of QE appear to have assuaged those concerns.

Figure 1: After decades as net sellers, central banks became net buyers of gold after the financial crisis

Gold: Will 2024 be a Breakout Year on Rate Cut Hopes?_1

The central banks' post-GFC gold buying contrasts sharply with the time when central banks were net sellers of gold from 1982 to 2007. This implies that pre-GFC central bank policy entrusted fiat currencies like the U.S. dollar, euro, yen, pound and Swiss franc as reserve assets more than gold. This relationship reversed since the GFC. By all accounts, that tendency continued in 2023 despite central bank rate increases boosting returns on fiat currencies to their highest levels since 2007.

Central banks aren't the only ones who tend to see gold as a currency. Strong and consistently negative correlations between gold and the Bloomberg Dollar Index (BBDXY) suggest that traders also see gold as an alternative to the U.S. dollar, not entirely unlike the currencies in Bloomberg's Dollar Index such as the euro and yen (Figure 2).

Figure 2: Gold and silver have negative correlations to daily changes in the Bloomberg Dollar Index

Gold: Will 2024 be a Breakout Year on Rate Cut Hopes?_2

What separates gold from central-bank-issued fiat currencies is that it pays no interest. As such, gold prices are typically averse to the prospects of higher rates. This, along with the strength of the U.S. dollar in 2021 and 2022, is likely what kept a lid on gold prices. Fixed-income markets went from expecting the Fed to keep rates on hold at zero for years in 2021 to accepting that the Fed needed to raise rates eventually to 5.375%. Since 2015, gold prices have almost always had a strong negative correlation with the daily change in Fed funds futures two years forward (Figure 3).

Figure 3: Gold averse to higher rates, correlates negatively with Fed fund futures

Gold: Will 2024 be a Breakout Year on Rate Cut Hopes?_3

Despite gold's failure to rally during the 2021-2023 surge in inflation, one could argue that gold is actually a pretty good inflation hedge, but it's one that anticipates inflation rather than react to it. Between October 2018 and June 2020, Fed funds futures went from pricing Fed funds two years forward at 3% to nearly zero. During this time, gold prices rose from $1,200 to $2,080 per ounce, a 73% rally. However, when inflation arrived in 2021 and strengthened in 2022, it wasn't great news for gold because it caused investors in short-term interest rates (STIRS) to re-evaluate their expectations for long-term Fed rates from 0% to 4.5%. So, while inflation may have lifted gold prices higher, the prospect (and later reality) of higher rates, pushed gold prices back down (Figure 4).

Figure 4: The prospect and reality of higher rates prevented gold from rallying from mid-2020-2023

Gold: Will 2024 be a Breakout Year on Rate Cut Hopes?_4

What caused gold to perk up last December and briefly break out to a new record high were prospects for Fed rate cuts in 2024 and 2025. For it's part, the Fed suggested in its “dot plot,” a sort of internal forecast among members of the Federal Open Market Committee (FOMC), that it was seeking to cut rates by 75 basis points (bps) in 2024. Fixed-income markets, however, are pricing for something much more dramatic, that is, for the Fed to cut rates by around 200 bps, with the first rate cut potentially coming as early as the Fed's March meeting.

While a move towards such pricing may have helped gold recently, it may pose a challenge for investors in gold in the future. For rate cuts to benefit gold, they may have to exceed the 200 bps that Fed funds futures are already pricing (Figure 5), meaning the Fed may have to cut rates to below 3% by mid-2025 in order to keep the gold rally going.

Figure 5: U.S. interest rate futures price around 200 bps of Fed rate cuts over the next 18 months

Gold: Will 2024 be a Breakout Year on Rate Cut Hopes?_5

Ultimately, how gold performs in 2024 and 2025 may depend on how the U.S. economy fares. A “soft landing” with minimal rate cuts along the lines of the 75 bps suggested by the Fed's dot plot may prove bearish for gold. By contrast, an economic downturn accompanied by more rate cuts that currently expected might send gold to new record highs.

Source: CME Group

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Michelle

Economic

Stocks

The S&P 500 (SNPINDEX: ^GSPC) had a remarkably good year in 2023. The benchmark index advanced 24% as a host of factors helped improve stock market sentiment, including a surprisingly resilient economy.

After that performance, investors might have forgotten than many pundits had forecast a recession starting last year. That never materialized, but the risk has not disappeared. In fact, a forecasting tool based on the Treasury yield curve -- which has a near-perfect track record in predicting recessions for more than 70 years -- currently shows its most severe reading since 1981.

Here's what investors should know.

The Treasury yield curve has reliably predicted past recessions

Treasury bonds are debt securities that pay interest based on maturity dates. Long-term bonds normally pay more that short-terms bonds because investors expect higher returns when they commit capital for extended periods. As a result, the Treasury yield curve -- a line plotting interest rates across all Treasuries (i.e., 1 month to 30 years) -- moves up and to the right under normal circumstances.

However, the Treasury yield curve becomes inverted when short-term bonds pay more than long-term bonds. That can happen when economic concerns cause investors to seek safety in long-term bonds (driving the yield lower) and avoid or sell short-term bonds (pushing the yield higher).

Inversions can happen at any point along the curve, but an inversion between the 10-year Treasury and 3-month Treasury has been a particularly reliable leading indicator of recessions. To quote the Federal Reserve Bank of New York, "The yield curve has predicted essentially every U.S. recession since 1950 with only one 'false' signal, which preceded the credit crunch and slowdown in production in 1967."

With that in mind, a popular Federal Reserve forecasting tool uses the Treasury yield curve to estimate the probability of a recession 12 months in the future. That tool currently puts the odds of a recession at nearly 63%, as shown in the chart below. Gray areas represent recessions.

This Recession Indicator Is Ringing Its Most Severe Alarm in 40 Years. Here's What It Could Mean for the Stock Market_1

US Recession Probability Chart

While 63% might not sound too bad, it is the most severe reading since August 1981. And since 1960, the U.S. economy has always suffered a recession within 12 months of a reading exceeding 50%. The only exception (so far) is the present time period.

Here's the bottom line: The probability curve indicates a good chance of a recession at some point in 2024. To quote the Federal Reserve Bank of St. Louis, the current probability would be "unprecedentedly high for a false positive."

The S&P 500 usually declines sharply during a recession

Before discussing how the S&P 500 performed during past recessions, I want to make one thing clear: Every forecasting tool is fallible no matter how good its track record. The current yield-curve inversion might be a false positive. Investors should view the Federal Reserve's recession forecasting tool as an estimate.

With that in mind, the U.S. economy has suffered 10 recessions since the S&P 500 was created in 1957. The chart below details the index's peak decline during those economic downturns.

This Recession Indicator Is Ringing Its Most Severe Alarm in 40 Years. Here's What It Could Mean for the Stock Market_2

Data source: Truist Advisory Services.

As shown above, the S&P 500 declined by an average of 31% during the last 10 recessions. To put that in context, the index is currently within a percentage point of its all-time high, so the implied downside would be about 30% if a recession does occur in 2024. Individual stocks within the index would drop and rise by varying amounts.

However, patient investors have nothing to fear. The S&P 500 has recovered from every past recession, and the rebound has usually been swift. In fact, the index returned an average of 40% during the 12-month period following its bottom during the last 10 recessions.

The most prudent strategy is to stay invested

Investors might be tempted to sell now and buy back in once the S&P 500 hits bottom, but there are two problems with that strategy. First, the recession forecasting tool could be incorrect. The U.S. economy might not slip into a recession, and the stock market could continue to move higher.

Second, if the U.S. economy does slip into a recession, it would still be impossible to know when the S&P 500 reached bottom. The average decline during the last 10 recessions was 31%, but that average includes declines ranging from 14% to 57%. Making guesses about the next recession would be gambling, not investing. Strategies that depend on market timing tend to fail.

Instead, the most prudent course of action is to stay invested through any downturn. The S&P 500 has increased 2,630% since January 1990, compounding at 10.2% annually, despite losing a substantial amount of value during the dot-com crash and the financial crisis of 2008.

That means any investors who had $100,000 in an S&P 500 index fund in January 1990 would have $2.7 million today, provided they stayed invested the whole time.

Likewise, any investors who added $195 per week to an S&P 500 index fund since January 1990 would also have about $2.7 million today, provided they ignored the ups and downs along the way.

Source: The Motley Fool

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Kevin Du

Economic

European Central Bank President Christine Lagarde said she does not expect a return to economic “normality” in 2024, despite seeing a balancing of certain data points throughout the last 12 months.

Speaking on a Bloomberg panel at the World Economic Forum in Davos, Switzerland, Lagarde described the post-pandemic period as “strange, extraordinary and difficult to analyze” and identified three trends that began to normalize last year: consumption, trade and inflation.

The pandemic saw spending fall and people's savings grow, while global trade was also disrupted. In October 2022, euro zone inflation hit 10.6% but dropped off in 2023, coming in at 2.9% in December.

“In '23 we have seen the beginning of normalization,” she said on Friday. “When you look at consumption for instance, around the world … consumption is still a driving force for growth, but the tailwind that we had the benefits of, are gradually fading,” Lagarde said. Consumption softened, she said, as the jobs market became a little less tight and consumers' savings reduced.

Trade, meanwhile, was disrupted by consumers' preference for buying services over goods in 2021 and 2022, Lagarde said. “But it is beginning now to really pick up and in October, we had global trade numbers that for the first time in many months was up.”

The World Trade Organization (WTO) expects trade to increase by 3.3% in 2024, per a forecast released in October.

Lagarde also noted the broad fall in inflation in 2023. “Around the world, inflation is coming down, and we have seen it in November [in] both headline inflation and core inflation,” she said.

“So that's what I call the normalization that we have observed in '23,” Lagarde said on the panel, adding somewhat cryptically: “And maybe you'll give me the floor another time to talk about it how it is not normality that we are heading to.”

In December, the ECB opted to hold rates unchanged for the second time in a row, shifting its inflation outlook from “expected to remain too high for too long” to expectations that it will “decline gradually over the course of next year.”

Speaking on the same panel, WTO Director General Ngozi Okonjo-Iweala agreed that the economy is “maybe moving towards normalization” but she described it as “not normal, because trade growth is still trending below GDP growth.”

Okonjo-Iweala noted uncertainties that make forecasting “difficult,” including geopolitical conflicts, disruption in the Red Sea and elections around the world.

A ‘new normal'

Germany's Minister of Finance Christian Lindner characterized the current economic situation as a “new normal.”

Speaking on the same WEF panel, he said: “Looking to what will come over the next years, Christine [Lagarde] said OK, we are in the process of normalization. I would say we are witnessing a new normal and 2023 marks this new normal.”

“Think about the race of artificial intelligence … think about the geopolitical tension and the threat of fragmentation we will have to deal with over the next years. The higher debt levels after the pandemic and the energy price hikes, which has shrunk our fiscal space to finance transformation, and given ... very little growth perspective of the global economy,” Lindner added.

“Has 2023 given me hope? … I would put it this way: It was a call for action because we have to rearrange some policies and … probably we are at the beginning of an era of new structural reforms,” he said.

Germany's economy — Europe's largest — contracted 0.3% year-over-year in 2023, its Federal Statistical Office said Monday. The office said that the German economy stagnated in the third quarter, implying the country has narrowly avoided a technical recession.