Capital Economics held two online Drop-In sessions on 5th December 2023 to discuss the outlook for 2024 and the risks to their forecasts. This Update summarises the answers to several of the questions that were received.
• Are there recessions coming in advanced economies? Recession risks seem to have dissipated given economies’ resilience so far. There was no crisis in the financial system as interest rates rose and, now that bond yields are falling, that threat has diminished. We still think that a lot of the drag from tighter monetary policy is yet to come and that the associated economic weakness is understated by consensus forecasts. We anticipate a period of very slow growth in the US and mild recessions across Europe. But this cycle has been unusual on both the demand and supply side given the distortions caused by the pandemic, so there is particular uncertainty over the timing and severity of any downturn.
• Is there a risk that inflation overshoots central banks’ targets again? It’s possible. The key risk here probably relates to oil prices and a potential escalation of the Israel/Hamas conflict. There is also a chance that tight labour markets and sticky wage growth keep core inflation elevated, mainly in Europe. However, our view is that inflation will generally fall back to target by the middle of next year as energy inflation stays subdued and core rates decline as demand softens. Indeed, we suspect that the bigger risks to inflation are to the downside, stemming especially from the possibility that central banks keep interest rates too high for too long. (This is one of the major risks that we set out here.)
• Which Developing Market (DM) central bank will be first to cut interest rates? Our forecast is that the Fed will narrowly be first to cut (in March) given the clear evidence that core inflation and wage growth are falling in the US. But the big picture is that most major DMs will be reducing interest rates next year, and in several cases by more than markets expect. (See our Central Bank Hub for more detail and other policy rate forecasts.)
• What explains the resilience of labour markets and will it continue? Given that trends in unemployment tend to lag those in the wider economy, it is not that surprising that we haven’t seen major job cuts so far. After the severe shortages experienced during the pandemic, firms might well have chosen to hoard workers. What’s more, their recent pricing power has allowed them to maintain headcounts without suffering a significant decline in profitability. Unemployment has begun to rise in some economies and we suspect that this process has further to run, but we do not expect a severe labour market downturn.
• Will high government debt affect the economic outlook and where is the situation worst? Government debt surged as a result of COVID and projected debt trajectories have deteriorated as long-term interest rates have risen. Despite this, we suspect that the US fiscal stance will be little changed next year. But various euro-zone economies including Italy will come under pressure to tighten policy. Germany will also need to tighten the purse strings for constitutional reasons despite the relatively healthy state of its public finances. This fiscal adjustment will reinforce a generally negative trend for the euro-zone in 2024.
• Will China's recovery continue next year? What is your view on the property sector? China should continue to experience a cyclical recovery on the back of improving consumer confidence and the ongoing effects of fiscal support. Measure to encourage banks to lend to investors should have some success (see here), but the key problems facing the property sector are structural ones including demographics, which will act as significant headwinds to any recovery.
• Economists say that more stimulus is needed – what is holding Chinese authorities back? The fiscal stance is already loose, and now that concerns over the exchange rate have dissipated we suspect that more monetary policy support will be forthcoming. That said, Chinese policymakers are unlikely to push very hard on the accelerator since the structural nature of China’s problems limits what can be achieved.
• How big are the risks to global growth from developments in China? As the world’s second largest economy, developments in China have a significant arithmetic impact on global growth. But China is not a major source of demand for advanced economies’ exports. The main casualties from a weaker Chinese economy would be the exports of its Asian neighbours and those of commodity producers like Australia, Chile and South Africa. Commodity prices would be hit too, but for DMs the associated fall in consumer price inflation should mitigate the effects of weak demand in China. There is some risk of hard landing fears sparking more general financial market stress. Here again, Emerging Markets (Ems) would be most exposed, especially those with large external debts. But it’s worth noting that even the market fallout of the intense China hard landing fears in late 2015 was not bad enough to cause meaningful damage to global economic activity.
• How should we think about different growth rates in EMs and DMs? EM GDP growth has outpaced that in DMs so far in 2023 and should continue to do so in 2024 by a wide margin. But the pace of growth is likely to vary widely across the emerging world. India should remain the standout performer, growing by more than 6% next year. Other parts of South East Asia should record rapid growth too. Elsewhere, some economies that have been through a period of weakness this year – including parts of Central Europe, Chile and Colombia – are now starting recoveries. In contrast, several major EMs that have been surprisingly strong this year, including Brazil, Mexico and Russia, are likely to slow and by more than most expect.
• Has debt in EMs reached unsustainable levels? And where are the risks greatest? On the private sector side, the biggest risks are in China – private sector borrowing is higher and has risen by more than in any other major EM. Most of the relates to lending to the real estate sector, and the property downturn will continue to put strain on the financial sector. Elsewhere, the bigger risks relate to public sector debt. In a handful of cases, most notably Argentina, large and unsustainable foreign currency debt burdens mean a restructuring will be needed in the near term. There are slow burning debt problems in South Africa and Brazil while debt trajectories are also likely to start rising in other parts of Latin America and Central Europe.
• What’s the outlook for capital inflows into EMs? If we’re right that global growth will disappoint, there may be a bit of turbulence for capital flows to EMs. But later in 2024, an acceleration in global growth and falling interest rates in the US should support a pick-up in foreign inflows. Potential beneficiaries include India (due to rapid growth) and Turkey (where investors are becoming more optimistic that the recent policy U-turn is the real deal). We also think there may be a cyclical recovery in inflows to China as interest rate differentials shift in its favour.
• Will AI boost productivity growth next year? Will it cause job losses? We are optimistic about the scope for AI to drive a marked pick-up in productivity growth, but we suspect that this will materialise towards the end of the decade and not as soon as next year. While it may be tempting to put the recent strength of US productivity down to AI, this hypothesis is weakened by the fact that there has been no evidence of a tech-related boom in equipment and intangible investment. When the AI boom does come, we doubt that it will cause a surge in unemployment and in many cases will complement rather than replace existing jobs.
• Have equilibrium real interest rates risen? Yes, there are good reasons to think so. Several of the factors which have weighed on equilibrium interest rates including the global savings glut and large swathes of people saving for retirement have already gone into reverse. Meanwhile, other factors have added to the upward pressure including the desire to invest in AI and the green transition. You can find the in-depth analysis that we conducted, but in short we think that US equilibrium real rates have already risen to around 1% and will rise to as high as 2% in the next decade.
The opinions expressed are those of Capital Economics and are not necessarily shared by other economists or St. James's Place Wealth Management.
The article is not intended to be a recommendation to buy.
Jennifer McKeown, Chief Global Economist, firstname.lastname@example.org
William Jackson, Chief Emerging Markets Economist, email@example.com