A tight labour market, eroded but still abundant ‘over saving’, a catch-up in service consumption, the tail of the post-Covid comet – these are the key factors that have boosted growth beyond expectations. When paired with overall sound balance sheets in the private sector, they have helped growth stand up far better against the threat posed by surging inflation and aggressive monetary tightening.
At a time when monetary tightening is really starting to bite and the support from the post-pandemic recovery is waning, disinflation is allowing us to anticipate a soft landing, rather than a collapse in growth. This assumption is not without risk either, as we have seen with the spike in oil prices since the summer. This rebound, triggered by Saudi Arabia’s production cuts, is a clear indication that, with no competing suppliers, OPEC+ remains in control.
“First among equals” (although that status is disputed), the US economy’s resilience has continued to surpass expectations, to the point of near-unsustainable speed: as always, most of it has come from consumption, which is starting to flag. Pandemic-peak surplus savings (estimated at USD2,300bn, c.10% of GDP in March 2021) have dropped by half. After gradually declining, even dipping below its pre-crisis level in September 2021 (2017-19 average close to 8% of income), the savings rate appears to have stabilised, but at a very low level. In addition, hiring has hit a slower pace, job openings have dropped sharply, wage growth has declined, the quit rate is down significantly, and the participation rate is building back up. Credit card use is on the rise. Finally, outstanding revolving credit hit record levels: delinquencies have risen, and its growth has already begun to slacken.
So will there or won’t there be a recession (understood as two consecutive quarters of contracting GDP)? The answer to this question will tell us what kind of landing we will have. In its ‘authentic’ version – no recession – we cannot rule out a soft landing. However, our central scenario calls for a very slight recession at the turn of 2023-24. The 2024 landing is unlikely to be too hard: average growth is expected to hit a very respectable 2.1% in 2023, before slowing to 0.7% in 2024, leaving average inflation to continue its sharp decline (4.2% and 2.7% respectively in 2023 and 2024 after 8% in 2022).
In the Eurozone, the slowdown is already obvious. Adding to weaker global demand, which is clearly visible in the poor performance from exports, comes the crushing one-two punch of a commodity price spike in 2022 and an earlier impact than expected from interest rate hikes. These shocks are having very mixed effects on the Eurozone’s major economies and making the zone’s economic situation a tricky read. Yet overall, how hard (or soft) a landing we feel will depend on the combined effects of two opposing forces: gradual transmission of the most aggressive monetary tightening the Eurozone has ever seen, against the growing deflationary dynamic expected starting in Q423 and bringing average inflation down from 5.6% in 2023 to 3.0% in 2024 (after 8.4% in 2022). With monetary transmission at a peak in 2023 and business activity just stable over H223, average growth is projected at 0.5% after 3.4% in 2022. The scenario of a modest recovery in growth (0.9% in 2024) is based on domestic demand alone: that is, consumption, enjoying the gains in purchasing power afforded by deflation and the lagged adjustment of nominal wages to past inflation
In the emerging universe, despite the slowdown in growth in developed countries, generally satisfactory albeit unimpressive growth is emerging. The scenario comes with high uncertainty. Among the risk factors are US interest rates staying “higher for longer,” a specific and costly constraint for the emerging economies and the risk of a slowdown in disinflation that could disrupt monetary easing, whether planned or already begun by the central banks intent on preserving their credibility; however, the big risk is China, whose much-anticipated recovery has been a disappointment – there is ample questioning around whether China can support its economy. The Chinese authorities have already implemented two major types of measures: they have very conservatively eased monetary conditions; and they have taken measures to assist the real estate sector. These actions are starting to have an impact. Our scenario calls for growth to stabilise at a level that is still satisfactory, albeit relatively weak with respect to past performances (5.1% and 4.5%, respectively, in 2023 and 2024 after 3% in 2022). But the risk remains of an insufficient or unfit countercyclical response that does not do enough to stabilise projected growth and restore confidence. And with it, the risk of prolonged weak demand and a correction in the real estate sector, along with a lasting negative impact on growth.
In terms of monetary policy, central banks are unlikely to let down their guard. In the wake of massive monetary tightening, even though their inflation targets are still some way off, central banks have recently opted to hit pause. Barring an unpleasant inflation surprise that necessitates further tightening, we expect this pause to continue and key rates to remain high. We certainly should not expect rapid rate cuts.
In terms of monetary policy, central banks are unlikely to let down their guard. In the wake of massive monetary tightening, even though their inflation targets are still some way off, central banks have recently opted to hit pause. Barring an unpleasant inflation surprise that necessitates further tightening, we expect this pause to continue and key rates to remain high. We certainly should not expect rapid rate cuts.
The Fed held the Fed funds rate (upper bound) at 5.50% in September but published a dot plot suggesting a drop of just 50bp in its key rate in 2024, rather than 100bp previously. This validates the risk of rates staying “higher for longer” and confirms that the Fed wants to avoid a premature easing of financial conditions. Our central scenario continues to be of a long pause followed by cuts beginning in June and bringing the upper bound of the Fed funds rate to 4.75% at end-2024. Nonetheless, most of the risks point to a more hawkish trend, and we cannot rule out another increase in Q423. In the Eurozone, while the risk of one last rate hike cannot be ignored, our scenario calls for the ECB to hold its rates at their current level (4.50% refi rate) at least until the end of summer 2024. Although it plans to continue its reinvestments until the end of 2024, the ECB could also decide to accelerate its quantitative tightening by stopping its reinvestments in the PEPP in early 2024..
Stubborn inflation, resistant growth and resolute monetary tightening have naturally caused bond yields to surge. A scenario where bond yields moderate slightly is taking shape in the US with forecasts for 10Y yields at 4.00% at end-2023 and 3.50% at end-2024. However, this scenario seems premature in the Eurozone, where the ECB has a clearly restrictive policy and may attempt to reduce its balance sheet more quickly. As such, we expect the Bund to be at around 2.60% at end-2023 and 2024. The “USD smile” story just keeps on going. With the US economy holding up, the Fed determined to bring inflation under control, a favourable interest rate differential and episodes of risk aversion, the USD’s short-term appeal is undeniable.
Read our publication: World – Macro-economic Scenario 2023-2024: a delicate balance – 6 October 2023