Macro Markets Podcast Episode 46: A Deeper Dive Into Our 11 Macro Themes for 2024
Matt Bush and Maria Giraldo, leaders of our Macroeconomic and Investment Research Group, join the Macro Markets podcast to provide commentary on our 11 Macro Themes for 2024, which set forth some of the issues and trends we believe are likely to shape monetary policy and investment performance this year.
This transcript is computer-generated and may contain inaccuracies.
Jay Diamond: Hi, everybody, and welcome to Macro Markets with Guggenheim Investments, where we invite leaders from our investment team to offer their analysis of the investment landscape and the economic outlook. I'm Jay Diamond, Head of Thought Leadership for Guggenheim Investments, and I'll be hosting today. We are recording this episode on Wednesday, January 17th, 2024. Today, we're going to be discussing our 11 Macro Themes for 2024, which we published last week. Now, in most year, we publish ten Macro Themes, but this year ours goes to 11. That's for all you Spinal Tap fans out there. Now listeners can find the Macro Themes chart pack at www.guggenheiminvestments.com/perspectives. Now the Macro Themes represent the work of our Macroeconomic and Investment Research group and represent just a few of the trends that we believe are likely to shape the investment environment in the year ahead. We're going to go through the 11 themes with the leaders of our macro group, our U.S. economist Matt Bush, and our investment strategist, Maria Giraldo. Welcome back, Matt and Maria, and thanks for taking the time to kick off the year with us today.
Matt Bush: Great to be back.
Maria Giraldo: Thanks, Jay. Always happy to be here.
Jay Diamond: All right. Now we've grouped the 11 themes into five broad categories. So, let's begin with the themes related to our economic outlook. The first one being “Soft Landing Hopes Will Give Way to a (Mild) Recession.”
Matt Bush: So, the economy is in a really good place right now. Unemployment's below 4 percent, we have real GDP growth solid, but gradually cooling off, and inflation has come down significantly--by some measures already, back to 2 percent. So, with all this Goldilocks economic data, the market has gotten really optimistic and is really assuming economic conditions are going to stay this way and at the same time, interest rates will come down. And this belief in a soft landing is actually pretty typical with what you see late in the economic cycle--belief that the economy has come through the worst turmoil and good times are ahead. But a consistent theme in our outlook is that there are a lot of risks and things that could go wrong still. On the one hand, we've seen a steady slowdown in the labor market over the past year, especially in more cyclically sensitive industries, and there's really no reason that slowdown should suddenly stabilize now. And so, we could see further weakness in the labor market that could spill over into consumer income and consumer spending. Another risk is that Fed tightening may have not fully flowed through to the economy yet. Credit growth has slowed sharply, but that was matched by expansive fiscal policy last year, and we could see a bigger drag this year. And then on the other hand, you have risk in the other direction where inflation picks back up, whether that's due to new supply shocks or just companies seeing a better outlook and raising prices more. An upturn in inflation would really upset the soft landing balances. It would lead to more hawkish Fed policy. So, there are reasons to be positive about the economy. We don't expect a deep economic downturn, but we think relative to the way the market is priced, there's still a lot of economic risks out there that keep odds of a recession elevated.
Jay Diamond: Now, let's move on to the next theme under economic outlook, “Resilience Gives Way to Bifurcation.”
Maria Giraldo: Now, I'll talk a little bit about that one, and I think that picks up a lot on what Matt's talking about with there still being very elevated recession risks. And one of the things that's feeding into that is the fact that one of the tailwinds for 2023 that is now fading as we look out to 2024 is this idea that all that stimulus that came into the environment in 2020 and 2021 is now really quickly fading. And that's something that was very uncertain at the beginning of 2023, whether it all needed to drain or just some of it needed to drain. I think as we moved in through the economy, it seemed clear that all of that liquidity really needed to run out. And so, if you're looking at our chart back, that I think does a good job with a lot of these pictures and how we're framing these themes, what we see is that all the excess savings that really helped provide support for consumption is now gone for particularly the consumers in the lower income quartiles. So, the bottom quartile, for example, have already fully exhausted that excess savings. The top quartile still has a little bit of it left, but a lot of it has been exhausted. And those type of trends, I think, is going to give way to this bifurcated theme, and we're seeing it across a number of different areas. We also see it in the corporate credit world where the smaller companies are really struggling to cover their ongoing interest expense. So just again, another side of that excess savings fading very quickly. Now we really want to dig more and more into how this is affecting small businesses that make up 50 percent of employment in the U.S. economy, but that data is very difficult to track because, generally speaking, those type of reports only come out annually or semiannually. They might be survey based, etc. So, in the chart pack we point to a chart that's produced by the Bank of International Settlements, BIS, that shows in the upcoming next several years, if you control the debt maturities by the companies’ revenues, right? If you do sort of a debt to revenue maturity schedule, the smallest companies are the one that have the most amount of debt coming due. In other words, their highest ratio of debt to revenues, and that's going to be a huge headwind for the next several years. It only kind of gets worse as we look out to 2026. Again, all of that is to say that I think this year we're going to see this resilience theme that came a lot from the concept of excess savings give way to a bifurcated theme in 2024.
Jay Diamond: Thanks, Maria. And thanks for pointing out that the chart pack. While it's not necessary to listen to this podcast, certainly does enhance the understanding because the charts are terrific. So again, guggenheiminvestments.com/perspectives, if you want to open that up. Now the next three themes are in this broad category of policy related themes. So, let's start with “Negative Money Supply Growth and Draining of RRP Are Key Risks and May Usher in Deflation.” Why don’t you start, Matt, by explaining what RRP stands for?
Matt Bush: So that's the Fed's Reverse Repo Facility, which essentially is a good metric of how much excess liquidity there is in the system. And from a policy perspective, the market is overwhelmingly focused on the outlook for Fed rate cuts, and that's definitely a big important part of the story. We expect the Fed will be cutting rates pretty aggressively this year, but the idea that once the Fed starts cutting rates, the economy is out of the woods, there's no more risk of that policy front, we think is wrong. First of all, we have to think of the lagged impacts of past Fed tightening and its consequences, and one of the most striking consequences has been the collapse in growth of money supply. Just like surging money supply growth was an early warning of inflation risks building in 2020 and 2021, a 4 percent contraction in money supply that we saw last year, which is the largest since the 1930s, could be a sign that inflation is going to fall more than many expect. And more broadly, it's also a sign that liquidity conditions are becoming more challenging. We're seeing that in bank lending growth slowing down significantly. We could see more spillover effects in 2024 as this liquidity continues to dry out.
Jay Diamond: Now the next theme, “Massive Treasury Issuance Will Continue to Weigh on Rates and Crowd Out Other Issuers.”
Matt Bush: So, this is another piece of the policy puzzle that doesn't get as much attention as the outlook for Fed rate hikes or rate cuts. We saw fiscal concerns could be an important driver of markets back in September when the market became concerned about a flood of Treasury supply. Since then, we've gotten a bit of a reprieve as Treasury has shifted more issuance toward bills and as the Fed has signaled, rate cuts are on the way, but the underlying concerns haven't gone away. The fiscal deficit in 2024 is going to be roughly the same size as 2023, around 6 percent of GDP. That's a very large from a historical perspective or in comparison to other countries, especially considering that the economy's in pretty good shape, but you had this huge fiscal deficit. These deficits are going to be an ongoing issue no matter what the election outcome is. There's very little political will to either cut spending or raise taxes. We have a long list of pressures calling for more spending, whether it's geopolitical risks, whether it's aging demographics. So for interest rate markets, the Fed cutting cycle is going to be the dominant driver this year. But the presence of these big fiscal deficits and the need for the market to absorb a lot of Treasury supply will limit how far yields can fall, we think. And this structural high fiscal deficit environment that holds up interest rates also means private sector borrowing is being crowded out, ultimately resulting in a less dynamic private sector in favor of greater government spending.
Jay Diamond: Now, our third theme under the policy category is “The End of the ‘Free Money’ Era Will Burst Lingering Asset Price Bubbles.” Maria, what does that all mean?
Maria Giraldo: Yeah, this is related to a concept that we think that there's still potentially some remnants of the prolonged era of Q.E. and the low rate environment the market really hasn't fully priced in yet. And as Matt said, there's a confluence of different factors that are impacting markets. But in general when we're looking at the central bank balance sheets, for example, we can see that they peaked in 2021 and in early 2022 and have been on a general decline. That's something that's going to continue to impact markets, we think to the downside in the chart pack, as I mentioned, again, great visuals, but you can see the peak with central bank balance sheets historically has been related to how the equity market moves up until about last year. Last year, we continued to see a shrinkage in global central bank balance sheets, but then the equity market actually started to move in opposite directions. Let's think about some of those lingering asset price bubbles that had lingered, I should say, post-COVID into 2020 and 2021, but have since deflated just for comparison. You have cryptocurrencies, for example, where broader index measures show that the cryptocurrency index is down 50 percent still from the peak. Another one is SPACs. There was a big SPAC bubble in 2021, that's down 40 percent from the peak. But again, as our chart shows, the equity market really hasn't seen that repricing that has occurred in other bubbles as a result of the shrinking in global central bank balance sheets. So, we're just sort of highlighting there's a little bit of a disconnect there. Some maybe might push back and argue that that's not fair comparison because the equity market has seen increased earnings, but even when we look at something like P/E ratios, which then controls for earnings, we still think that they're way too elevated, considering the fact that central bank balance sheets are shrinking and expected to shrink over the next year. So, there's a little bit of repricing there that that has to happen. And again, it's just an effort for us to continue to point out that some of the clouds in the macro environment and the market and policy environment haven't really cleared. And that's something that we should remain vigilant of.
Jay Diamond: The next two themes are specific downside risks that you're calling out. To start, “Record Global Elections and Geopolitical Instability Will Lift Economic Uncertainty.”
Maria Giraldo: This theme is intended to highlight that we are operating in a record global election backdrop. It's in an environment, too, where there are wars raging and intense geopolitical uncertainty. And elections tend to breed even more uncertainty because you know how global economies deal with tensions is just always goes back to people, right? Their relationships, political and economic agendas. So not knowing the outcome of an election, of course, it's hard then for the market to just count on a status quo type of environment. We just saw the outcome of one such election in Taiwan where the outcome was less than desirable for China. The headlines were filled with commentary about how voters dismissed China's warnings and how China would react not, and that doesn't make for a very stable environment when the U.S. is managing its relationships abroad. Now, as it relates to the market, we are going to come back to this concept of geopolitical risk toward the end of our discussion, when we talk about the opportunity that it's breeding, but we do think that by the end of the year, as a world moves through these global elections, we're likely to see some surprises along the way, and that's going to keep feeding into heightened economic uncertainty.
Jay Diamond: Now, the next downside risk is one that we and others have been talking about for a long time, but clearly there's no end in sight, and it is “Commercial Real Estate Stress Will Intensify and Spill Over to Small Banks.”
Maria Giraldo: Yeah, and good point that a lot of participants have been talking about this already, and I think actually investors are maybe growing a little bit desensitized to what's going on in the commercial real estate market and then the office market in particular, because it's in the headlines a lot. Growing vacancies, the maturity wall is something that then newspapers continue to harp on, and this concept of Armageddon in the commercial real estate market. So, we apologize for piling on to the growing chorus of the doom and gloom, but we do think it's an important theme and it's going to continue to have an impact, mainly because there is a sort of circular reference that's happening within the commercial real estate market and the banks and especially the small banks. So, we track very closely the FDIC’s data just to see how banks are doing fundamentally, and we can clearly see that in the non-owner-occupied category of banks’ loans books, the distress rate is climbing very quickly on a quarter-over-quarter basis. The recent increase was the largest we've seen since 2009. Now with the commercial real estate market means in addition to buyers is lenders. It needs both parties to step in in order to help price discovery, and that's exactly what's not happening. Because the banks are seeing their loan books deteriorate in the space, they're going to stay defensive and they're not likely to provide credit, and that's going to just continue to feed back into the commercial real estate market. It will continue to deteriorate the price discovery and values--continue to depress it--which is going to feed back into the banks. So, there's just this sort of feedback loop that is likely to keep the commercial real estate market stuck for many years in a period of just having to operate under a higher interest rate environment and a stricter lending environment. So, we think this is something that's going to continue to weigh on risk sentiment and markets in general.
Matt Bush: And just to add to that feedback loop, we talked about bifurcation earlier and the weakness that's likely to come for small businesses, who small banks have a disproportionately large exposure to and who also are obviously major occupants of commercial real estate. So, that's kind of this third pillar of weakness that creates this feedback loop and is why we talk about almost two economies developing where there's the smaller bank, smaller business stress, commercial real estate aspect that looks to be in a lot of trouble, whereas the larger companies, the higher income households, are in comparatively much better shape.
Jay Diamond: We also have an upside risk in our themes for 2020, and its “Technological Innovation and Competition Will Continue to Transform the Economy.”
Matt Bush: Yeah, there's a lot of encouraging things going on the technology side of the economy, and we think the biggest upside risk for 2024 is that we get strong productivity growth. And that would be doubly positive because it means both we see good economic growth and because it expands the supply side of the economy, it doesn't generate inflation. Productivity is notoriously hard to measure and even more difficult to predict, but I think there are encouraging trends going on that can help us feel good about the outlook for productivity, and one of the biggest of these is technological innovation. We're obviously seeing a lot of hype around artificial intelligence, and that's spurring a lot of new investment and new spending. Our chart shows that revenues at the Magnificent Seven tech companies could surpass total revenues of all 2000 companies in the Russell 2000 index, which shows how tech dominated the market has become. And there's also a strong policy push for more domestic investment in high tech manufacturing. We saw new construction of manufacturing facilities explode in 2023 as fiscal incentives from the CHIPS Act and the Inflation Reduction Act spurred more interest in building things in America. This building of new manufacturing plants alone probably boosted real GDP growth last year by around half a percentage point, so a sizable contribution. More of this reshoring of production, especially if it's focused on advanced technologies like semiconductors, would be a positive also to a slowdown in other parts of the economy.
Jay Diamond: Great. So, the things we've been discussing are very broad topics, but we do bring it back to market outcomes. And so, to conclude the categories, our fifth and last category, we have market outcomes that we're going to be looking for in 2024. So, to begin with, “Fed Easing Cycle Will Drive Long-End Rates Lower Than Anticipated.”
Matt Bush: So, I mentioned earlier, we expect the Fed will be cutting rates substantially this year. Our base case, as we see the first cut in March and most likely cutting out at 25 basis point increments at each meeting. After that, the inflation data has been really encouraging over the last few months and at the same time, the Fed is growing more concerned about some of these downside risks to the economy we've talked about. So, it's pretty clear they're headed toward rate cuts. This transition to Fed cuts is going to be a positive tailwind for fixed income performance in 2024. Typically, from the time the Fed stops hiking to a year and a half later, which would line up with the end of 2024, we see the 10-year Treasury yield falling by about 150 basis points on average in past cycles. In this cycle, the 10-year yield is still roughly where it was at the time of the last hike, meaning there's still could be a lot more downside from here. And this transition to a cutting cycle was also important, as it should lead to more relative outperformance of longer duration fixed income instruments compared to cash holdings. A lot of investors are sort of hiding out in money market funds right now, but with rates headed lower, they'll be earning less on that cash and at the same time missing out on the rally in longer term rates.
Jay Diamond: The next market outcome that we discuss is that “Private Credit Will Cannibalize Banks’ Role in Leveraged Credit Further.”
Maria Giraldo: Yes, and let's go back to what I mentioned about the commercial real estate market. The banks themselves have been tightening underwriting standards, not just for commercial real estate, but just across the board, so for commercial and industrial loans as well, for credit cards, etc. In the private credit space--and this is kind of this broader CNI average corporate type of company--there has been a solution to step in and that has been the private credit market and private lenders who, along with private credit, have combined with private equity to provide solutions. And that has caused a shrinking in banks’ role in leveraged credit, which is something that really began a long time ago, really post-financial crisis as a result of a lot of regulation on the banks. So, we just think that that's going to continue, especially the environment just feeds that type of participation from private credit. We've seen a lot of flows into private credit as investors have had a strong demand for credit with yields where they have been, but not a lot of supply for a lot of the reasons that we talked about. One, just being tightening standards causing a decline in issuance in the broadly syndicated market, but we think that over the next 12 months, that's likely going to continue. We'll see a little bit of a pickup of supply, but still very limited relative to where it was in 2021 and 2022. We're going to continue to see increased demand for credit as a result of just yields where they are, and so that's going to continue to breed opportunity in private credit markets. But for us, the big focus is going to be on how that impacts the bank's role and in particular how that maybe sows the seeds for future credit cycles.
Jay Diamond: And finally, our 11th theme: “Out of Chaos Comes Opportunity in Fixed Income.”
Maria Giraldo: So, this we did something a little bit unique here. We're big students of history at Guggenheim, and we really wanted to study what happens historically when you have heightened interest rate volatility, the potential for heightened equity market volatility, which we haven't talked about in this podcast, but it could return this year just given we're still at inflection points in the economic environment. What happens when we have heightened geopolitical uncertainty and when we have heightened economic uncertainty? And so, we went back and pulled together a variety of different indexes to combine these and create a sort of “Guggenheim Chaos Index.” We wanted to see what the performance was of these different asset classes in an environment where chaos is when it's low, when it's medium, when it's high, and what we found was that high quality credit tends to perform really well or a lot better, I should say, than riskier categories, particularly like equities in an environment where we have high chaos. If you are of that belief, if you're watching and monitoring the global election cycle, you still feel like it's a very elevated, highly uncertain economic environment. We would invite you to take a look at that chart and just recognize that high quality credit can provide that buffer for downside risks in that type of environment. And especially given where yields are, we do think that yields and coupons are providing that support and that cushion against downside risks. That creates an opportunity to allocate to high quality fixed income.
Jay Diamond: So, what's included in the quote unquote, “Guggenheim Chaos Index”?
Maria Giraldo: It’s credit spreads, it’s interest rate volatility. So, if you're really in the weeds in the market, the big one to follow there is the MOVE index. We've got equity market volatility, so that's VIX. There's a U.S. economic uncertainty and geopolitical uncertainty indexes, all of those go back to the 1970s. So, there really aren't a lot of periods of high uncertainty. They'll generally tend to culminate around recessions, but not always. And what we find is that we're sort of gradually moving into a period where uncertainty is increasing and it's setting up for an environment where high quality fixed income should outperform.
Jay Diamond: Terrific. Matt and Maria, thank you guys so much for walking us through your excellent work of the 11 Macro Themes for 2024, before we let you go, are there any other thoughts you'd like to share with our listeners?
Matt Bush: I’ll just echo that I think that last theme is really the culmination of the other ten themes, which is that in an environment where there are so many risks to the economy, to the policy outlook, the stability and predictability of high-quality fixed income returns looks particularly attractive in this environment.
Jay Diamond: Thank you both again for your time and your insight. I hope you come back and visit with us again soon to go over how these themes are progressing. And thanks to all of you who have joined us for our podcast. If you like what you are hearing, please rate us five stars, and if you have any questions for Maria or Matt or any of our other podcast guests, please send them to firstname.lastname@example.org and we will do our best to answer them on a future episode or offline. I'm Jay Diamond and we look forward to gathering again for the next episode of Macro Markets with Guggenheim Investments. In the meantime, for more of our thought leadership and the 11 Macro Themes for 2024, please visit guggenheiminvestments.com/perspectives. So long.
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