Stocks (^DJI, ^IXIC, ^GSPC) continue their optimism rally while pricing in the Federal Reserve's possible 2024 interest rate cuts ahead of looming inflation risks.

Charles Schwab Chief Global Investment Strategist Jeffrey Kleintop explains how the Fed and global central banks could view inflation's trajectory in 2024, listing economic and commercial headwinds afflicting countries like Japan.

"I'm a little concerned that inflation won't prove as passive as many of the markets and maybe even some of the central bankers are thinking," Kleintop tells Yahoo Finance. "Inflation [has] historically come in waves — we can see that in the '70s, we can see it in the '80s, even in the early '90s when inflation picked up to 5% in countries like the US, the UK, Canada, and Australia.

Click here to watch the full interview on the Yahoo Finance YouTube page or you can watch this full episode of Yahoo Finance Live here.

This post was written by Luke Carberry Mogan.

Video Transcript

AKIKO FUJITA: Well, stocks a little mix this morning with the NASDAQ and S&P looking to continue momentum after posting 10 straight days of gains.

The rally sparked by expectations that the Fed will cut interest rates next year, but our next guest says those very expectations pose one of the biggest threats heading into 2024.

For more on this, let's bring in Jeffrey Kleintop, Charles Schwab chief global investment strategist.

Jeffrey, good to talk to you today.

What's wrong with great expectations going into 2024?

JEFFREY KLEINTOP: Well, I guess the problem is there's so much priced in, right?

We're looking at six rate cuts from the Fed, six rate cuts from the ECB, and now even maybe six rate cuts from the Bank of England.

That's a high hurdle.

Certainly, it's helped to drive the stock market up 16% since late October, but it's pricing in a lot of optimism.

I'm a little concerned that inflation won't prove as passive as many of these-- the markets and maybe even some of the central bankers are thinking.

Inflation has historically come in waves.

We could see that in the '70s.

We could see it in the '80s.

Even in the early '90s when inflation picked up to 5% in countries like the US, the UK, Canada, and Australia, we saw subsequent waves, meaning that inflation goes up, comes back down again.

You can see in this chart the blue line there, the history in the 1970s, the purple line is this experience here for the US.

But it's not just the US that looks this way.

Most countries when they see a big wave of inflation, they get a subsequent wave.

Now, I don't believe we're headed to new higher levels of inflation, but I think there are a number of reasons why it could prove volatile in the year ahead.

First of all, we've got potential supply chain problems both in the Panama Canal and in the Red Sea.

We've got energy issues that may crop up next year.

We've got a number of different challenges, I think, in housing and a few other areas that could create some volatility to inflation, that would keep central banks from cutting on the aggressive path the market has already priced in.

RACHELLE AKUFFO: And Jeffrey, when we look at how investors are looking at these rate cuts coming up next year, is it a case of the risk being more that the markets are getting ahead of themselves or really underestimating the risk of why the Fed might be cutting if it's related to perhaps weaker economic activity?

JEFFREY KLEINTOP: Look, you're right.

It could be a little bit of both.

I think we will see some weaker economic activity in services, you know.

Taylor Swift saved the economy in 2023, but it'll be hard for her to do that again in 2024, simply because all of the entertainment and travel spending that we've seen boom in the US.

And Time Magazine's Person of the Year was certainly the US's most valuable person of the year as well.

But as we look to even beyond the US, in Japan they saw the biggest tourism money coming into the country, most tourist receipts in terms of income they've ever seen in that country.

So it was a big boom in travel and entertainment spending.

That is on a path to slow in 2024 even as mainly maybe manufacturing begins to stabilize.

So your point is a good one.

The economic outlook for the rest of the world is a pretty soft one next year along with earnings growth.

We continue to see earnings being revised down here for the fourth quarter.

And that all comes together to a market that's really been pricing in maybe a Goldilocks outcome of still relatively robust economic growth and aggressive rate cuts.