Merlin Weekly Macro: 2024 in retrospect

“Two out of three ain’t bad”, with apologies to Meat Loaf who probably did not have monetary policy in mind when belting out “Bat Out of Hell” in 1977. Two shavings and a hold. That was the final burst of moderated enthusiasm by the central banks at the end of 2024. Having started late (its first interest rate cut was in September, after the Bank of England and the European Central Bank were already out of the traps in the summer), the Federal Reserve made its third consecutive reduction in borrowing costs in this post-peak phase in the cycle; at 4.5% US interest rates are now a percentage point lower than their recent high. As expected too the European Central Bank (ECB) cut its deposit rate by a quarter percentage-point to 3%, its fourth such move, also a point below the summer peak. Disappointingly, it was only the Bank of England which, faced with inflation that has risen for two consecutive months and at 2.6% is nearly a point higher than in September and its highest in over six months, and with an economy that has stagnated again (forcing the inevitable 1970’s retro headlines this week shouting “STAGFLATION RETURNS!”), felt unable to join the seasonal cheer with a cut of its own: we stick at 4.75%, only a half point below our own peak of 5.25%.

Away from down among the weeds of the data, step back and look at the bigger picture: it is a mess.

The US: prefacing a new chapter with déjà vu

At the beginning of 2024, markets fully expected seven interest rate cuts from the Federal Reserve (Fed) by the year end. Instead they got three, albeit the first was the Fed choosing to make a splash with a half-point cut to get the ball rolling (and for reasons which seem increasingly unclear). Liberal commentators have been quick to point out that Trump has been bequeathed a strong US economy with low unemployment; this is true. But that relative buoyancy has been maintained through a programme of egregious state spending by the Biden administration and a deficit which is out of control. If Trump inherits a growing economy, he is also lumbered with a debt mountain of $36.1 trillion (122% of GDP), a cool $8 trillion greater than when he left office in 2021 (it is only fair to point out that he himself was not shy in spending taxpayers’ cash: including the pandemic mitigation measures, he too added $8 trillion to the burden in his first period). Trump on the stump majored on inflation and the cost of living: US inflation is rising again towards 3% even before he takes office and launches his global trade war with a universal barrage of tariffs. It is not surprising that US government borrowing cots are soaring again. Today, despite central bank rate cuts of a full point from their post-pandemic peak, at 4.56% US 10- Year government bond yields are the highest they have been since 2007, barring the spike in October 2023 and the Hamas attack on Israel.

The UK: praying for D:Ream

In very different circumstances, the UK also has the highest government borrowing costs in nearly two decades; here it is for reasons that are only too obvious in the light of Rachel Reeves’ budget fiasco. Business confidence has collapsed; companies are being forced to cut back on investment and employment while also expecting to recover the additional costs arising from the £22 billion business tax Exocet launched by the government at employers. On fiscal policy Keir Starmer and Rachel Reeves are all at sea, jetsam blowing in the wind in a political maelstrom all of their own making. This week, Starmer appeared to reverse his position made only a fortnight ago that it would be irresponsible to promise no more tax rises, implying instead that he will make no more calls on families and businesses; no doubt the devil is in the terms and conditions and the disclaimers. Five months in to a new government, having already been forced to press the re-set button, markets are left wondering what, if anything, that Starmer utters can be readily taken at face value (in an additional twist of incoherence, Pat McFadden, Chancellor of the Duchy of Lancaster, announced that he wants ‘disruptors’ from the tech space to work a tour in the civil service to liven things up, be provocative, to lob grenades to overcome what Starmer describes as the civil service mindset of the “tepid bath of managed decline”; the ambition is completely laudable but is the very antithesis of Starmer’s simultaneous stated aim of greater government intervention and more direct control).

Europe: you would not make it up

As for Europe, where to begin? As we discussed in our most recent column, investors appear relaxed about the political and economic dysfunction in the eurozone as so many incontinent governments fail to make headway on managing their deficits and debt while trying to generate growth. The reason is simple and was reinforced in the ECB’s December policy statement: the central bank is standing by with its ‘Transmission Protection Instruments’ (TPI) to control any incipient contagion. In plain English its anti-fragmentation strategy is in place to prevent the eurozone enduring a systemic meltdown. In a programme of explicit bond yield manipulation, if needs be, the ECB will buy the bonds of the countries that are financially stressed e.g. France and Italy (driving the yield downwards), while simultaneously selling those of the more stable members e.g. Germany and Finland to drive their yields upwards thereby controlling the spread between the two to minimise the risk of arbitrageurs and speculators making contagion a self-fulfilling prophesy. The ECB sees no obvious irony or contradiction that it presides over a system labelled “Monetary Union” in which it deploys a single all-encompassing interest and exchange rate for its unitary currency, and yet needs differential bond policies to prevent the system from literally dis-integrating.

That it needs such a strategy betrays the sheer illiteracy of the eurozone’s financial structure: a one-third baked ‘system’ comprising monetary union but with neither debt union nor fiscal union to match. TPIs were designed in an emergency response to Georgia Meloni’s then new Italian government failing to get a grip on the deficit in 2022; the spotlight is once more shining on Rome as she attempts to reconcile a budget that meets the promises she made to voters to reduce taxes, while having to satisfy Brussels that the deficit and the debt are under control and trying to avoid punitive delinquency penalties (the deficit is forecast to rise to 3.3% of GDP in 2026 instead of the 2.9% originally planned, above the maximum permitted 3%; government debt will still rise further to 137%, more than double the 60% maximum allowed under the Stability Mechanism rules). Those penalties are the ones that the ECB would need to deploy TPIs in mitigation against to prevent the bond markets taking fright if Rome and Brussels fail to bridge their differences. At least the budget has passed in the Italian parliament; its next hurdle is the Senate.

It remains Alice in Wonderland stuff in Europe; what attraction Europhile Keir Starmer sees personally in re-hitching the UK’s cart to this hobbled, febrile and fragile nag is difficult to fathom.

2024 in retrospect

As we round off 2024, let us just cast an eye back on a momentous year. Much is encapsulated in that Omaha Beach photo taken in June at the Normandy commemorations to which we regularly refer.

• Far from being trussed up in jail as Biden hoped, a triumphant Trump is about to be reinstalled in the White House while, defenestrated and forlorn, Biden disappears into the wilderness. His has not been a great presidency.
• Olav Scholz has suffered the ignominy of losing a vote of confidence on top of his federal government collapsing; Scholz is likely to go down as the most useless and least memorable German Chancellor in post-War history.
• Emmanuel Macron is in office but not in power. It is entirely his own fault. France is in political limbo for at least seven months until a new election can be called. Will 2025 be the year of Marine Le Pen? Or is her destiny to be disbarred if found guilty of corruption?
• With a 174-seat majority, Starmer’s new government has already been accurately dubbed the “Loveless Landslide” (the feeling appears mutual). As they said in very different circumstances in 1997, “Things can only get better”. Let’s hope so, otherwise it’s going to be a long five years. 
• Little noticed but still pertinent, at the heart of the EU with its spiritual home in Brussels, six months on from its federal election, Belgium still has no functional government.
• The war in Ukraine approaches its fourth year. Already a global conflict by proxy, 2025 looks like being a new and very different phase with Trump in the White House. Whatever the outcome, there will be wide-ranging consequences. We will explore further in the New Year.
• We will still be writing about the Middle East in a year’s time and not just because it is within days of being Christmas Week.
• With only a few days remaining of 2024, the S&P 500 is up 23.7% year-to-date. What chance of it repeating the trick in 2025? Let’s see!

On that cheerful note, from all of us on the Jupiter Merlin Independent Funds Team, we wish you a very happy Christmas and a prosperous New Year.

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