After over a year’s interest rate hikes by the US Federal Reserve (Fed), heightened inflation, robust consumer spending and a heated labour market in the US has finally showed signs of cooling in the fourth quarter of 2023, and we have seen the US economy move into a phase of slower growth, says Jason Yu, head of multi-asset management, Asia at Schroders Investment Management Hong Kong.

Whilst inflation remains under control, this scenario is expected to allow for more flexibility for the Fed to adjust its monetary policy in 2024. Unless an unforeseeable ‘black swan’ event happens, financial markets seem to be under the consensus that the US will likely cut rates in 2024.

Whilst such market expectations are currently being reflected in interest rates and stock prices, it seems unlikely for the Fed to loosen its policy stance all at once. Investors should therefore exercise caution, and not be so overly optimistic about any rate cuts in the US during the first half of 2024.

The Fed is likely to begin rate cuts in the second half of 2024

Investors might want to note that there are still other variables that might affect the timing and magnitude of future interest rate cuts. We believe that there is higher probability for the Fed to start tightening in the second half of 2024. This is because policymakers may need more time to evaluate economic data and determine the inflation trend, better so to avoid cutting rates prematurely, which could reignite inflation and cause further damage to the economy.

Meanwhile, inflation appears to be contained for now, looking at the relatively moderate levels seen in the US labour markets and in consumption. This reduces the urgency for the Fed to rush into rate cuts in the first half of 2024 for the purpose of stimulating the economy.

In 2024, we are more convinced that a cooling US economy and moderating inflation would be the reasons for the Fed to cut rates, rather than economic recession. Based on the current economic situation, US economic fundamentals appear to remain resilient. Schroders’ current baseline forecast is for a soft rather than hard landing for the US economy.

We also believe an immediate and severe recession is unlikely. Investors may want to consider companies and asset classes that could benefit from cooling inflation.

Monitor the effects of economic stimulus policies from China

If the US were to shift its monetary policy stance, what would that mean for Asia and emerging markets?

In the past, continuous interest rate hikes by the Fed had resulted in a prolonged period of strength in the US dollar, and yield-chasing funds had flown into high interest-rate markets like Europe and the US. Asia and emerging markets were often affected. However, with US interest rates peaking, investor capital could potentially flow back into Asia and emerging markets in 2024.

As for mainland China and Hong Kong, their economic interdependence has increased in the post-pandemic era. Therefore, the driving force behind Hong Kong's economy will likely depend on mainland China’s economic fundamentals, and whether authorities will introduce more supportive economic policies within 2024. This will be a key factor that will influence the direction of Hong Kong's economy. If the Hong Kong economy is able to rebound, it can attract capital inflows as US interest rates peak.

Stay vigilant for ‘black swans’

Looking ahead, it is important for investors to learn from past experiences and be prepared for sudden 'black swan' events.

While there are signs of cooling in the US economy looking at data, investors should remain vigilant and closely monitor changes in economic indicators, such as whether the labour and consumer markets will suddenly strengthen again, which could lead to the Fed raising interest rates.

Investors should also pay attention to geopolitical risks that could again trigger higher commodity prices in 2024, potentially leading to a resurgence of inflation and undermining expectations of interest rate cuts by the Fed.

The US presidential election is also a factor for investors to watch. The ability of the US president to implement policies will depend on whether he, she or they can gain control of the US Congress. A divided US government would force compromise, helping to moderate extreme factions within each party and provide a more stable policy backdrop for investment, thereby potentially supporting financial markets.

Until the results are announced in November, issues around the election will likely continue to simmer and may affect market conditions.

Given geopolitics and the US presidential election are uncontrollable external factors, investors should be prepared for different scenarios. From a diversified asset allocation perspective, they can consider a more diverse, flexible approach to managing their investment portfolios with an aim to reduce exposure to interest rate risk.

Investors can also explore different asset classes to better navigate inflation and interest rate changes, cope with market volatility, and capture potential returns and capital growth opportunities.

By Jason Yu, Head of Multi-Asset Management, Asia at Schroders Investment Management Hong Kong