Inflation remains a key contributor to global risks, particularly in the US. Since June 2023, inflation has fallen below 4%. While this initially looked promising, inflation has never fallen below 3% and remains sticky. As a result, most market participants expected the Fed to cut rates several times during 2024. Recent developments have changed these expectations dramatically. At its most recent meeting, there was a significant chance that the Fed would even raise rates again. At its meeting in early May 2024, the Fed is holding its rate between 5.25% and 5.5%. While rate hikes are less likely in the near term than before the May meeting, some economists do not see a cut before 2025. Whether interest rates are lowered is increasingly dependent on the US labour market. With its current strength, the economy can tolerate higher interest rates. If the labour market shows signs of trouble, cuts are likely to come sooner than expected. While inflation will remain a key criterion for such a decision, the focus seems to have shifted to the labour market. Figure 1 shows the development of inflation and interest rates in the US, the EU, the UK, and Switzerland.
In the EU, inflation has been on a healthier decline. Inflation in the EU has fallen to 2.6% in March 2024, the lowest level since the start of the inflation spike. Interest rate cuts now seem much more likely in Europe than in the US. Even in the UK, inflation is coming down to manageable levels and the BoE has hinted at earlier cuts than previously thought. Switzerland, which has been unique during soaring inflation, was even able to already to lower its interest rate from 1.75% to 1.5% in March 2024.
Gold started surging substantially in March and April 2024 and reached a new record high of $2,401 per ounce. At the time of writing, gold is trading slightly lower at $2,335, as shown in Figure 1. Gold reaching high prices seems reasonable in the current state of the economy. However, the exact timing does not support this breakout. Gold flourishes in high inflation, high uncertainty, and recession ecosystems. High uncertainty is certainly true with continued geopolitical tensions, e.g. Russia-Ukraine, Israel-Palestine-Iran, etc. While there is no recession currently, indicators imply a recession for years now, which is further supported by the growing tensions around the world. High inflation was present, and inflation is still moderately high. Nonetheless, interest rates, even on a real basis, are high, which historically has shown to behave anticyclical to gold. The current view on a “higher for longer” ecosystem, which implicates high interest rates for a longer time, also does not favour gold. While uncertainty and a potential recession are valid reasons for increases in gold prices, it further benefits from the fact that the asset will likely perform well whether there is a recession or not, which not many other assets can claim. Additionally, central banks have been accumulating a lot of gold, especially China and Eastern countries. Perhaps, Eastern central banks have acquired the amount of gold Western countries are ready to sell, which leads to a shortage of supply and increasing prices.
Although oil prices were relatively steady at moderate to high levels over the past year, prices started increasing. Most recently, a potential intervention by Iran in the conflict in Israel led oil to surge further in price. At its peak in 2024, WTI crude oil traded at nearly $88 per barrel, which fell slightly to the current level of $86 per barrel, as shown in Figure 1. This decline is attributed to the current view that Iran has refrained and is expected to continue to refrain from getting involved in the conflict. Nonetheless, geopolitical tensions in the Middle East pose a significant threat to oil supply and could result in price shocks should the current situation escalate. Excluding major escalation, it is likely that oil will remain relatively stable throughout 2024 with limited upside and downside potential. The current economic situation and at least the short-term outlook appear to be beneficial for oil demand. Improved manufacturing data from the US, China, and India boost the requirement for oil. Interest rate cuts on the horizon are likely to boost economies, which also results in higher oil demand. On the supply side, the OPEC+ held the supply relatively tight to maintain moderate to high prices for oil. In case oil should move significantly higher, production would likely increase from the OPEC+, as it would push alternatives which hurts oil's long-term outlook. Nonetheless, in the case of escalations, especially in the Middle East, supply could be constrained, which could result in strongly soaring oil prices that cannot be resolved quickly.
2023 followed the core theme of 2022 with a key focus on inflation and interest rates. At the beginning of 2023, inflation was a huge concern, due to its high level. In the US, inflation was at 6.5% and already declined substantially from its peak in June 2022 at 9.1%. This trend continued in 2023 until it reached its bottom in June 2023 at 3%. Since then, US inflation remained steady between 3% and 4%. The EU and the UK saw a very similar development of inflation throughout 2022. Their respective inflation started at around 5.5% in January 2022 and rose to 10.5% by the end of 2022. As soon as 2023 started, inflation in the EU started to decline and eventually declined to as low as 3.1% in November 2023. Despite this promising development, inflation began to increase again to 3.4% in December 2023. While the UK’s inflation development was almost equivalent to the EU’s in 2022, this changed in 2023. Inflation in the UK remained above 10% until April 2023, at which point inflation was at 10% or higher for almost an entire year. Nonetheless, UK inflation also came down later in 2023 and reached the 4% mark at the end of December 2023. Based on the overall relatively similar development of inflation around the world, it is likely that inflation will stay at elevated levels in the short term. Another key reason for relatively stale inflation is that central banks stopped hiking their interest rate for a while now in 2023. Figure 1 summarizes the development of inflation in the US, EU, and the UK.
With the soaring inflation in 2021 and afterward, central banks had to react. Financial markets enjoyed rates close to zero, if not negative, for a long time. As a response, central banks started raising their interest rates. The Bank of England was the first to raise its interest rates in December 2021. The Fed followed in March 2022 and hiked its rate in every meeting and by a higher amount on average than the BoE or the ECB. The BoE did so too, but did smaller hikes on average. The ECB followed in June 2022, but they did not hike at every meeting. At the start of 2023, the interest rate in the US was already at 4.25% compared to 3.5% in the UK and 2.5% in the EU. Consequentially, the ECB hiked more in 2023 but did not reach the same heights as in the US or UK, which are currently at 5.25%, while the ECB’s interest rate remains at 4.5%. With interest rates now higher than inflation rates in each of those economies, most market participants expect interest rate cuts in 2024, especially due to an elevated possibility of a recession ahead. |
|