Listen: The Decisive | Ep.27 - 2024 in Review: Economic fault lines

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Kristen Hallam   

Hello, and welcome to The Decisive Podcast. I'm your host, Kristen Hallam. As we approach 2025, we are reflecting on our key themes for 2024. In this episode, we're revisiting some key moments and insights from our previous episodes on the theme of economic fault lines. To jog your memories, here's how we describe this theme in our annual big themes report for 2024. Regional divergence in inflation rates and monetary policy is exposing economic fault lines around the globe. The ongoing stress caused by tighter financial conditions and growing geopolitical tensions appears likely to tip some economies into recession. As Mainland China navigates economic headwinds, its Asia-Pacific neighbors will add fuel to the main engine of global growth. A renewed vigilance is required for potential vulnerabilities such as a slowdown in bank lending and persistent large deficits. Here's what our global economist, Ken Wattret, had to say at the start of 2024 about our expectations for global GDP growth. 
 

Ken Wattret   

Well, we think growth prospects look challenging in many parts of the world, including in North America and Western Europe, where we're forecasting below potential annual real GDP growth rates this year, consistent with the goal I mentioned earlier of bringing inflation rates sustainably back to target. To give you some numbers in the euro area, for example, we're forecasting annual real GDP growth of around 0.5%, a very insipid growth with various headwinds expected to continue to weigh on economic activity, including like pretty much everywhere, the lagged effects of tighter financial conditions. There are some variations in the expectations of growth within the region, the more industry-sensitive economies in Europe, including the biggest, Germany, they're expected to continue to struggle. Further south, we had a boost from pent-up demand for services, which benefited the tourism-sensitive countries in 2023, but that pent-up demand has already faded. So they're also expected to lose growth momentum this year. The U.K. is also forecast to perform quite poorly. We're expecting a real GDP contraction annually in 2024 with various headwinds, including difficulties in the household sector continuing to weigh. Somewhat more positively in the U.S., we're expecting annual growth of around 1.5% this year. That's below trend, but a little better than what we're expecting in most of Europe. In part, that reflects some carryover effects from strength in the U.S. economy in the autumn of last year, but it's also reflecting some other factors, including supportive fiscal policy. Again, that paints a contrast to what's happening in Europe. Looking further afield, we expect to see relative strength in some of the regions, including Asia Pacific, in particular. That's expected to help avert a global hard landing. Within the APAC region, we're expecting continued robust expansions in several of the larger economies, including India and Indonesia. And another region where we expect relatively brisk growth is sub-Saharan Africa, although its share of global GDP is much lower than that for APAC. So it has less global resonance. The bottom line is we think from a global perspective, real GDP will grow annually by a little over 2% this year, but that's below estimates of the potential rate, and it's below 2023's projected growth rate, which is a little below 3%. 
 

Kristen Hallam   

Our Purchasing Managers Index team of economists pick up early signals from their extensive survey data. Let's hear Economics Director and Head of Nowcasting, Paul Smith, describe what the PMI data are saying about global growth in an episode from November. 
 

Paul Smith   

Global economic growth as measured by our JPMorgan composite PMI has been broadly steady compared to that September reading. So growth still a little bit below trend, characterized really at the moment by modest demand growth and a slightly softer labor market. But on the plus side, the inflationary pressures are broadly contained. There's still a little bit of a gap between what I'd call subdued manufacturing performance and private service sector growth in terms of output orders, employment. And that weakness in manufacturing is quite evident in the United States. and especially so in the Eurozone where challenges related to energy competition, trade, structural factors are all tending to weigh on performance at the moment, especially in the region's traditional industrial powerhouse economy of Germany. Now I think that implies perhaps that things are a little bit better, relatively speaking, elsewhere for goods producers around the world. So growth in India continues to power ahead, whilst in China, output is rising modestly and actually at its best pace for 4 months in October. Japan remains in contraction territory, but only just and not to the same extent as the U.S. and Eurozone. 
 

Kristen Hallam   

Let's get a little more color on bright spots in the global economy from Hanna Luchnikava-Schorsch, Head of Asia-Pacific Economics. 
 

Hanna Luchnikava-Schorsch   

What we have seen so far is that the economies which are exporters of technology and semiconductors, in particular, have benefited from the tech upcycle and the adoption of artificial intelligence. We have seen very strong merchandise exports growth in Hong Kong, Taiwan, South Korea, so high-income technology exporters. At the same time, the economies which are more exposed to commodities exports, including Australia, Malaysia, Indonesia have seen some mixed performance where growth recovery has been lagging so far. We have also seen that exports to the U.S. has been very strong, whereas merchandise exports to China have been lagging as well as merchandise exports to the European region. And that means that going forward, the economies which are more exposed to China, where we will see continuous slowdown, will probably be most vulnerable on the product side and a lot will really depend on the further adoption of artificial technology. So what we are seeing within the region itself is that, again, the economies with both exposures, including South Korea, Hong Kong, but also Malaysia being the most vulnerable to slow down next year. But one thing in addition to that dimension is that growth this year and next year is also being supported by domestic demand and, considering that easing cycle on the monetary policy side is also about to begin, if it has already not begun for many economies, that will provide additional impetus to growth and in a way, compensate for some of the slowdown on the export side. One of the bright spots, again, I would mention would be India, where we do see some deceleration of growth from a previously strong expansion of 8.2% last year. But at the same time, government's focus on infrastructure investment, both physical and digital is supporting growth. That's where we will continue to see strong performance among the large economies within the region and globally. 
 

Kristen Hallam   

Let's zero in on the world's largest economy, the U.S. with our Co-Head of U.S. Economics, Ben Herzon. Here's what Ben had to say about our expectations for U.S. growth in our June 28 episode. 
 

Ben Herzon   

We do expect tailwinds that have been boosting growth in 2023 to diminish and go away that will contribute to the slowdown. The dollar has been strong of late. This will weigh on net exports in the forecast. And we also expect that a secession of what has been rapid gains in equity values will weigh on consumer spending through traditional wealth effects. And all these factors that contribute to a slowdown in GDP growth will set the unemployment rate on a gradually rising trend. Loosening labor market conditions and other factors will then set core consumer price inflation on a path to 2%, allowing the Fed to begin cutting rates later this year. 
 

Kristen Hallam   

To hear more about the role of consumer spending in U.S. growth, here's Michael Zdinak, a Director in our U.S. economics team, who leads the U.S. consumer market service. Michael is speaking in our Halloween-themed episode on holiday spending. 
 

Michael Zdinak   

That shift does represent something that's very, I think, different about the consumer after the pandemic that we don't talk about enough. And that's this idea of the forever shopper or if you're a Glengarry Glen Ross fan, the ABCs of the U.S. consumer, always be consuming because they're always looking for a deal, and they're always looking to spend money. Don't bet against them because they will spend the money. And if you're listening to earnings calls and people are talking about a challenging macroeconomic environment, ask yourself, are they really adjacent to a challenging macroeconomic environment? Or do they just have the wrong mix of products on the shelves or the wrong strategy for the current economic conditions because people have jobs. They have money. Inflation is coming down. The Fed is cutting interest rates heading into next year. There's a lot of reasons that we expect sentiment to improve and for the outlook to look a lot less like below-trend growth, which is where we started this year and a lot more like trend-like growth of around 2% for the economy. That's a challenge for businesses and consumers and economists because that means that our expectations for unemployment rising and inflation coming down faster are being challenged. That's where we're going to -- the serious discussions we're going to have headed into next year of where do we think unemployment will end in 2025 and what do we think that means for not just consumer demand broadly, but inflation because when people have jobs, they're still willing to spend, that puts upward pressure on prices. 
 

Kristen Hallam   

Michael's comments provide a good segue into a review of how our inflation expectations have evolved in 2024. Here's what Ken, our global economist, had to say at the start of 2024. 
 

Ken Wattret   

We do expect consumer price inflation rates to continue to fall in 2024 as supply and demand continue to rebalance. Although in some advanced economies, we're not expecting Central Bank inflation targets to be achieved sustainably until 2025. And that's because achieving those targets is likely to require an easing of labor market conditions and lower wage and unit labor cost increases, and those 2 factors take some time to materialize. Wage growth rates are generally topping out, but the lags in that process can be rather long. But we also need to keep an eye on various risks to our inflation forecasts. One is commodity price trends becoming less of a disinflationary force, the materials price index, which is compiled by our colleagues in pricing and purchasing, that troughed in the middle of 2023, and that's expected to rise gradually this year and also in 2025. And there are also some factors as well, which we need to monitor in other areas, higher-than-expected food inflation, for example, due to weather-related issues, including El Nino, that's another risk. But the bottom line is we're expecting that the improvement in consumer price inflation that we saw last year will continue this year. 
 

Kristen Hallam   

Here's what Ken had to say about inflation at the midyear mark. 
 

Ken Wattret   

Consumer price inflation rates have largely continued to trend downwards, although they have proved to be somewhat stickier than expected, particularly in certain areas, and that's vividly illustrated by comparing our estimates of average core goods and services inflation rates in 5 key economies. Now core goods inflation is typically more sensitive to global factors like commodity price trends, supply chain conditions, and that inflation rate has tumbled. According to our calculations, it turned negative for the first time since early 2020 in these 5 economies on aggregate, and it's fallen by around 9 percentage points from its peak back in 2022. Now in contrast, the services inflation, which is less tradable, typically more labor cost driven and usually more sensitive to domestic economic conditions, that's just been edging downwards. It's heading down, but it's been very gradual so far according to our estimates at the latest data point available, which was for April, it fell to 4.8%. That's about 1.5 percentage points below its peak in 2023 and still well above the rates consistent in the past with central bank inflation targets being met. Now we're continuing to forecast that services inflation rates will moderate as wage and unit labor cost growth rates decline, but that's a process that's taking some time. 
 

Kristen Hallam   

Speaking of the labor market and wage trends, let's hear what Emily Crowley, who leads our pricing and purchasing research team had to say about that in an October episode of the podcast. 
 

Emily Crowley   

Another big thing is the switch in sentiment, right, but we have seen less business confidence in growth for 2025. We are starting to see things start to slow, especially in those developed economies. So that is resulting in slower hiring intentions. We're seeing employers are exercising caution. We haven't seen mass layoffs. There have been some industries, in some sectors, thinking about the tech industry, in particular, where we have seen an uptick in layoffs or job reductions. But as we continue to move forward and start to see unemployment rates moving higher and that's the feeling that if I let people go now, I'm not going to be able to find a replacement that's been leading to this job retention, job hoarding, we might see some further relaxation and a little bit more churn entering those labor markets. So again, not great news for employees, but from an employer standpoint, those hiring conditions should be getting a little bit better. If we look at our long-term wage trend, this is something that I want to highlight is that if you look compared to 2019, when we look at what real wages are going to be doing, so that's wage growth minus inflation, those profiles are slightly higher. And again, it's going to be reflecting this issue that -- even though right now, we have the softer demand picture, the worst of the labor crunch is over, there are still some policy issues, structural issues that are going to underpin and keep that wage growth profile a little bit stronger. But for now, at least in the near term, because we've entered the softer demand environment, the worst of the labor crunch is over. 
 

Kristen Hallam   

So what has this all meant for monetary policy? Have central banks adhered to expectations? Where have we seen shifts in 2024? And what does that portend for 2025? Here's what Ken had to say at the beginning of 2024 about the prospects for monetary policy pivots globally. 
 

Ken Wattret   

Well, we're very confident in the prediction that we'll see a series of interest rate cuts across advanced economies during 2024 given the backdrop of subdued economic growth and moderating inflation. But the uncertainty really, I think, relates to the timing and magnitude rather than the direction. And we have seen financial market expectations of policy rate reductions shift a lot recently. I mean, for example, the current expectation is for around 150 basis points of policy rate cuts in the U.S. and Eurozone in total this year. That looks somewhat overdone in our view. On the positive side, recent U.S. inflation data have been more favorable and labor market conditions have shown signs of easing. They are 2 preconditions for the Federal Reserve to be thinking about cutting interest rates. And consistent with those developments, we're expecting 100 basis points of Fed rate cuts this year. With regard to the ECB, markets are pricing in a lot of rate cuts quite quickly. 325 basis point rate cuts are pretty much priced in as soon as June. That's too much in our view, given still elevated wage and unit labor cost increases, and we see Q2 as a more realistic timetable for an initial cut in rates. And we're expecting, again, a total of 100 basis points of cuts during the year as a whole. Rate expectations in financial markets in the U.K. have been a bit less exuberant, reflecting the more challenging inflation situation. Here, still, we have over 100 basis points of cuts by the Bank of England priced in by futures markets already beginning in May. That looks a little premature. In our view, our forecast is that the first rate cut will occur a little later, probably in August and for less easing overall given comparatively sticky inflation rates and quite high wage growth in the U.K. We should also highlight that the Bank of Japan notably is heading in a different direction. We're expecting an end to its negative short-term interest rates in the spring of this year. That, in turn, is expected to continue to support the yen. And as you mentioned, it's been a different story for some emerging economies. Unusually, we've seen many central banks in Latin America and emerging Europe, lowering their policy rates late last year, while the Fed maintained a tightening bias. That's not a normal course of events. Big picture-wise, the central banks already cutting rates generally tightened monetary policy early and forcefully in response to soaring inflation rates back in 2021. That allows the rate cuts to materialize earlier on the way down. And we're expecting more emerging market central banks to join in this easing before long. Those rate cuts that we've seen in those 2 regions are likely to become more widespread during the first half of this year as inflation prospects continue to improve. 
 

Kristen Hallam   

Let's take a moment to talk about Russia, a special case given the sanctions impacting its economy. Shuchita Shukla, a senior economist focused on emerging Europe, talks us through recent moves by the Central Bank of Russia. 
 

Shuchita Shukla   

So the CBR pivoted to monetary tightening in July last year in order to curb inflationary pressures, but also to support the beleaguered ruble. And of course, a weak currency aggravates imported inflation when domestic demand is resilient, and that's exactly what we've seen in Russia, where state subsidized corporate loans, pre-electoral fiscal expansion and the tightening of labor markets owing to the outflow of skilled labor since the beginning of the war, all added to the release of pent-up demand. In August of 2023, the ruble crossed the psychologically relevant mark of 100 per U.S. dollar, and that was a key trigger for the CBR to abandon its previous course of monetary easing as the currency lost about 40% of its external value at the time. So to date, the CBR has raised the policy rate from 7.5% to 16% and has also tightened capital control. But despite the decisive monetary policy response, the ruble has remained weak and volatile, and there are several reasons for that. Most importantly, the declining energy export earnings under Western sanctions has broken the currency's positive correlation with crude oil price gains. And at the same time, strong domestic demand and a speedy rerouting of supply lines away from the West have all contributed to an import rebound, which has increased the demand for Chinese yuan, which is the preferred currency for cross-border payments. Lastly, the fiscal rule around oil and gas windfalls have actually limited the CBR's ability to support the ruble by intervening in the FX market. And so this backdrop of weak ruble and persistent pro-inflationary factors has led the CBR to signal tighter for longer monetary policy over the next 2 years. We do expect a few cuts mostly in 2025 as we expect government spending to peak this year. But with our projections of above target inflation both this year and next year, we do will remain restrictive, and we see them ending 2025 still in double digits. 
 

Kristen Hallam   

But how does monetary policy actually work? I sat down with senior U.S. economist, Lawrence Nelson, before the Federal Reserve pivoted to cut rates in September. Here's what Lawrence had to say about the Fed's 2% inflation target. 
 

Lawrence Nelson   

It's been explicitly stated as the target by the Fed since 2012. Prior to that, it was implicitly 2%, but there was a lot of debate within the committee about whether it should be exactly 2% over what time horizon it should be hit. I don't want to say globally that it's everyone's target, but most other central banks, which have a price stability target, 2% is the target. So it's commonly accepted as an appropriate number. 
 

Kristen Hallam 

And here's what Lawrence had to say about the Fed's primary tool for achieving its goals of maximum employment and price stability. 
 

Lawrence Nelson   

The Fed has several tools and targets at its disposal, but first and foremost among them is the target for the federal funds rate. Federal funds are reserves held by banks in their Federal Reserve Bank accounts. Reserves in excess of those banks' liquidity needs can be lent to other institutions in need of greater liquidity. These federal funds loans are done on an overnight and unsecured basis. And then the federal funds rate is the interest rate charged on these overnight loans. So where the Fed chooses to set their target for the federal funds rate anchors short-term treasury yields and other interest rates. And when they lower that funds rate target, that is tantamount to easing policy because lowering interest rates causes rates to decline in financial markets. This loosening of financial conditions is necessary when the economy may be sluggish or inflation is low, and we need to give it a boost through some more stimulative financial conditions. On the other hand, raising the funds rate is equivalent to tightening policy. Tightening financial conditions would be appropriate when the economy may be overheating or inflation is too high and the Fed wants to restrict activity. 
 

Kristen Hallam   

And finally, we'll wrap up with a warning from Ken about government budget deficits. 
 

Ken Wattret  

Now another restraint on economic activity is high debt. And the final point I'll highlight is the need for governments in many of the world's largest economies to take action to bring down their budget deficits. Financial markets have generally been quite relaxed about these persistent high deficits, but there have been some warning signs recently of a shift in mood. That includes the spike in the OAT-BUND spread that we saw ahead of the French elections, and we think it's quite likely that we're going to be returning to this topic before long. 
 

Kristen Hallam   

And that's our look back on economic fault lines in 2024. Next week, we'll round up key insights around the themes of supply chain resilience, resource security and logistics rewired on our way to revealing our big themes for 2025. Until then. Thank you for listening to The Decisive podcast from S&P Global. Please join us for next week's episode.