Market expectations of rapid disinflation and a soft landing remain, but January has given a few new risks to the optimistic estimates of disinflation with no impact on the economy.

The first risk comes from the commodity complex and freight costs. Market participants have all but ignored the spread of geopolitical risk and assumed the extraordinary and counterintuitive decline in commodity prices in 2023 as something permanent. However, January has shocked analysts with a dramatic increase in freight costs and a significant bounce in oil prices. Furthermore, the December inflation figures in the eurozone proved that the base effect was an uncomfortably large driver of the consumer price index annual decline in November. In fact, all the components published by Eurostat in the December advance came significantly above the European Central Bank target.

Markets closed 2023 with the strongest rally for equities, bonds, gold, and cryptocurrencies in years. The level of complacency was obvious, registering an “extreme greed” level in the Greed and Fear Index.

2023 was also an unbelievably bad year for commodities, particularly oil and natural gas, something that very few would have predicted in the middle of two wars with relevant geopolitical impact and significant OPEC+ supply cuts. It was also a poor year for Chinese equities, despite slower-than-expected but strong economic growth and robust earnings in the large components of the Hang Seng index.

Although the Federal Reserve and the European Central Bank’s message regarding interest rate cuts seems clear, reiterating their commitment to reducing inflation, the market is expecting between five and six interest rate cuts, between 125 and 150 basis points, in the next twelve months.

This shows us the bubble bias of many investors. We live in a world where two generations of market participants have only seen rate cuts and massive liquidity injections. Central banks have created huge perverse incentives in markets that should have been prevented if they truly followed their mandate of stable prices. On top of it, the ECB faces another risk. It must avoid following the siren calls of interventionists if it wants the euro project to survive.

The year is ending with a significant level of optimism among investors, focusing on an expected string of rate cuts from the Fed and an estimated economic soft landing.

However, a soft landing is a very rare event. Since 1975, there have been nine rate hike cycles, and seven of them ended in a recession.

Why? We must understand that the concept of “landing” that the Federal Reserve repeats constantly is exactly that: a recession. A soft landing is a significant decline in the aggregate money supply, which entails lower credit and access to capital for families and businesses. There is no other way to lower inflation, which the extraordinary and unnecessary increase in the money supply in 2020 caused.