A Big Global Headwind for Stocks Has Ended

Soaring inflation in 2022, followed by the Federal Reserve’s monetary tightening campaign, is often framed in U.S.-centric terms. Many may see rising prices, rising interest rates, and higher borrowing costs as a uniquely American experience over the past couple of years.

But that’s not the case.

The reality is that rising inflation and central bank tightening were a global phenomenon, which ultimately led to major global central banks raising borrowing costs by 4,105 basis points over the past year and a half or so. Using data from the Council on Foreign Relations (CFR) Global Monetary Policy Tracker, I find that the world hasn’t seen the level of ‘synchronous monetary tightening’ since early 2006.(1)

Perhaps the most unique feature of this global monetary tightening event, however, was the pace and magnitude of rate hikes almost across the board. The CFR’s Global Monetary Policy Tracker compiles data from 54 countries around the world, ranking monetary policy as maximally tight (10), neutral (0), or maximally accommodative (-10). From July 2022 to September 2023, the tracker hovered above 8.

The downside volatility experienced across global equity markets in 2022 was rooted in these rapidly tightening financial conditions. In my view, the recovery that followed in 2023 was equity markets responding to economic resilience, but there were also expectations that the global tightening cycle was nearing its end. That turned out to be right—by December 2023, the CFR monetary policy tracker had fallen to -0.36, and the number of banks cutting rates exceeded the number of banks raising rates for the first time since the pandemic. In other words, by the end of last year, interest rates around the world started falling again.

Long-duration U.S. Treasury bond yields fell late last year, but to date, we have not seen any rate cuts from the Fed. 2024 should deliver a few. The Federal Reserve’s preferred inflation gauge, the headline PCE price index, decreased 0.1% in November and was up 2.6% year-over-year. Importantly, the 6-month annualized change of the PCE price index (1.9%) is right on target for the Fed, which I think gives them no choice but to cut. The benchmark Fed funds rate remains in a range of 5.25% to 5.5%, which is about double the long-term “neutral rate” of 2.5% to 3%.

Even if the economy continues to grow, the Fed can cut—as long as inflation does not deliver a negative surprise. In projections released following their December meeting, the Fed indicated rates would end 2024 in a range of 4.5% to 4.75%, which implies three 25 basis point rate cuts in the new year. The market generally expects more than three rate cuts, but forecasts tend to be a moving target.

Globally, the European Central Bank (ECB) and the Bank of England (BoE) both left rates on hold at their latest meeting, and the ECB is widely expected to be one of the first key central banks to cut rates in the new year. Markets are pricing in 140 basis points of cuts. The BoE is still telegraphing “higher-for-longer” to markets, but if the Fed and ECB cut rates, the BoE is almost certain to follow. Same for the Bank of Australia.

Taken together, it’s premature in my view to say that 2024 will be a year where all major central banks systematically slashed interest rates together, easing monetary across the globe. But I do think it’s fair to say that the global tightening cycle is over, which I think moves the world from ‘tightening’ to ‘neutral,’ with the next stop being ‘accommodative.’

Bottom Line for Investors

In just the past year, the number of central banks raising rates has declined precipitously, essentially marking the end of the most widespread tightening cycles in decades. This policy reversal does not ensure support for global asset prices going forward, and I’d stop short of calling it a tailwind for stocks in the new year. But it does mark the dissipation of a major headwind, which I think opens the door for strong earnings and growth to propel stocks in 2024.

1 Reuters. December 14, 2023. https://www.reuters.com/markets/rates-bonds/major-central-banks-hold-rates-steady-markets-eye-rapid-cuts-2023-12-14/

2 Council for Foreign Relations. December 2023. https://www.cfr.org/global/global-monetary-policy-tracker/p37726

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