In hindsight, what characterised 2023 were markets underestimating both the resilience of the labour market and the persistence of high inflation – and with it, the scale and pace of interest rate hikes. Near the end of 2023, markets are now pricing in central bank easing over the coming year, but in many cases not by much. That’s a surprise because economic outlooks, inflationary pressures and policy objectives are hardly uniform around the world. Identifying where rate expectations are most vulnerable to market repricing is a key theme for 2024. 

We believe that core inflation will converge towards central bank target levels next year, undershooting both market expectations and central bank signalling in the process. We also expect economic growth to be lower than current consensus expectations in 2024. As a result, we think that the US, eurozone and UK central banks will cut rates by more than the market is currently pricing in.

The major exception is Japan. While in much of the world, central banks are set to ease policy, we believe that Japan is about to embark upon a tightening cycle, with the Bank of Japan set to phase out its yield curve control policy and by April end the era of negative interest rates. Japanese tightening at a time when most other countries are easing policy should provide a boost to the yen relative to other currencies next year. 

Policy rate tightening exceeded implied 12-month pricing in every economy except Japan

Monetary policy was an important driver of global markets in 2023, and we expect it to remain so in 2024. With that in mind, here are our four top takeaways for investors.

1. The European Central Bank (ECB) to cut rates first, but the Fed to cut by more

Early cuts may cause European yields to fall earlier than those in the US and lead to the tightening of bond spreads in the peripheral eurozone. But we believe yield differentials will narrow as the year progresses: we expect the Fed to cut rates by 225bp, but the ECB by just 100bp.

2. Up then down for the US dollar

The US dollar should receive support from interest rate differentials until the Fed begins its easing cycle. So, we expect it to perform strongly at the start of 2024 but weaken from Q2, when we believe the Fed will start to ease. We think the Fed cuts a lot more than they are currently projecting, which is potentially significant for the USD.

3. Sterling to outperform the euro in the near term

Our inflation forecasts suggest that the ECB will have more scope to cut rates sooner than the Bank of England (BoE), despite weaker economic growth in the UK. The euro could weaken against sterling if the ECB is indeed the first major central bank to cut rates, but sterling could suffer if the BoE cuts rates aggressively later in the year.

4. Steepening yield curves may present opportunity

Slowing economic growth and rate cuts could lead to lower short-term interest rates. But government deficits and supply / demand issues for long-term bonds may mean long-term bonds yields stay sticky even as front-end yields fall. That dynamic would result in a steepening of the yield curve in the US, UK, and the eurozone next year. This could make steepening trades, which involve buying short-term bonds and selling longer-term issues, popular in 2024. 

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