European economies are building up their self-resilience capabilities, while a shallow recession will likely leave a mark on European financial markets. That’s according to Johannes Müller, global head of research at DWS, who outlined 7 scenarios to watch in 2024.

In the baseline scenario, with patience the inflation rate will approach 2%

Müller attributed the unexpected rise in inflation rates in the US to generous fiscal policies, particularly during the pandemic. Increased purchasing power, coupled with supply chain disruptions, led to heightened consumer spending and a supply shortage, causing a significant price surge. While fiscal policy adjustments were theoretically possible, the constraints of an election year made them unlikely. Consequently, the responsibility fell on monetary policy to raise rates patiently, absorbing excess savings. DWS’s present observations, including growing workforce participation, indicate that the impact of pandemic-induced excess savings is diminishing, pointing toward a potential decrease in inflation.

“In Europe, inflation had a different trigger, [the] Ukraine war. Now, for the Euro zone, the decline in oil price and the current inflation dynamics are running somewhat below the trend, depending on the oil price, and so we might even see more decline”, Müller said.

Central banks start moving towards neutral interest rates

“If the central banks have the mission accomplished in terms of getting the inflation genie back into the bottle, then central banks start moving towards the neutral rate, very slowly though. The Fed will be cautious and slowly. But nevertheless, we believe that next year they will start cutting rates. Looking at what is priced in markets today, markets will behave a little slowly.”

Significant influence of current geopolitical tensions on oil prices

“The transmission channel is the oil price. For instance, in the Middle East war, [if] we get an escalation and doubled oil prices. That would change the outlook.”

Müller added: “If you think about China, Taiwan, and the transmission channel will be global supply chains. We also would not expect as a baseline scenario that we get a substantial disruption in supply chains from conflict between China and Taiwan, we don’t expect that.”

In 2024, a year marked by global elections, expectations are set for policy responses that could significantly influence the economy

“It was The Economist who calculated that 60% of the global population is going to vote in 2024”. Notable polls include the US presidential election, European Parliament elections, presidential elections in India and national elections in Indonesia. Additionally, large-scale elections are anticipated in populous countries such as Bangladesh, Russia, Taiwan and South Korea, with several others contributing to the global electoral landscape.

DWS, in analysing market responses to election outcomes, identified a two-layered approach. The first layer involves an immediate shock to the markets due to surprising election outcome, resulting in imposing a risk premium. This leads to a decline in valuations and yields, typical market behaviour that diminishes within a few weeks, as observed in events like the market response to Brexit referendum. The second layer, occurring concurrently with the first, entails a more prolonged reassessment by the markets, leading to shifts in valuations that take an extended period to materialise.

“Over the second half of the year, depending on how polling goes for the US election, that the topic of corporate taxes will be back on the agenda, and that would change the outlook for US earnings, increasing cutting spending, that would be the Republican way.

The other way is the Democrats would increase income tax intake,” he said during the interview.

“The European Parliament elections, with a low voter turnout, [could] benefit the extreme parties. It’s going to be a difficult environment. But I think as there is not a lot of optimism concerning the political and the economic landscape for Europe, I don’t think it will come as a big shock for financial markets”.

More resilient supply chains in Europe

DWS researchers have, Müller said, concluded that in response to the challenges posed by covid and the Ukraine war on production and supply chains, Europe is actively working towards greater self-reliance in manufacturing. The realisation that Europe lacked the capacity to produce essential items like masks during the pandemic underscored the importance of building capabilities and reducing dependence on external sources, extending beyond masks to critical components like semiconductors.

Investments from companies in semiconductor production facilities in Europe aim to enhance capacity and ensure a stable supply chain, particularly for industries like automotive manufacturing. This strategic move is crucial for maintaining production continuity amid disruptions like the war in Ukraine.

Investment spending focus in digitalisation

When it comes to “European transformation,” Müller said, “there are a couple of areas where the need for investment spending is particularly obvious. One is digitalisation. The digital infrastructure does need modernisation to keep up with all the data we need to handle artificial intelligence. So, it’s not because we are expecting big business and big earnings from next year, but just to be competitive and still in business in 10 years’ time”

Shallow recession, pick high quality assets

Müller said he anticipated a “shallow recession, but nevertheless a recession is a weak environment”.

“First of all, [it] should be a good environment [for] high quality fixed income. And starting with sovereign bonds, but also one market segment, which is the European covered bonds, European government bonds and corporate bonds. Government bonds are niche products, and can act as a risk diversifier, with the prospect of central banks cutting interest rates next year. In the long run, I think equities are still the place to be.”