Global economic view, October 2024

I was recently asked to produce an update on the global economic situation and, while writing it, I thought it might be a nice change of pace for readers of the blog to hear about the economic situation outside of the UK.

I should caveat my overall global economic view by stating that I am not a global economic expert. Historically, I have focused on the UK, US and European economies and, because of its increasing significance, more recently, on China. I have much less experience of Japan, India, Indonesia and Latin America’s more significant emerging economies. Having said that, the US, Europe (including the UK) and China account for just over half of global GDP and it is still these economic blocks that ultimately dictate the health and growth of the overall global economy.

In this summary, I will focus my comments on these key constituents of the global economy, and my views about the outlook will obviously lean heavily on the specific characteristics of these closely linked but distinct entities. A longer-term perspective would inevitably have to pay much more attention to the high-population emerging economies of the future, but for the purposes of this blog, I have paid much less attention to their individual growth credentials.

After commenting on the outlook for the global economy, I have added a few words at the end on financial markets with a focus on equities and currencies.

As always, I value your feedback. If you find this type of content interesting, please do let me know!

–– Neil

Recent history

The global economy has been through a very turbulent four years but is now beginning to emerge into some sort of “normality” in which the extraordinary policy settings of recent times can be set aside. Albeit that we are all familiar with what has happened, it is important to recognise that the world’s monetary and fiscal policymakers, in a very short space of time, have had to lurch from extraordinarily supportive policy during the global pandemic to, at least in monetary policy terms, following Russia’s invasion of Ukraine, the most restrictive in nearly two decades. In some ways, it is remarkable that these events have been navigated without more damage being inflicted on the global economy’s health. Indeed, the US and UK economies, in particular, have confounded negative consensus expectations and performed much better than was expected. Of course, this has, in turn, prompted concerns about the persistence of service inflation and wage growth and led to an especially cautious approach to reducing official interest rates. It is this debate about the speed of policy loosening that has become the focus of attention amongst most economists in recent months, and it is generally seen as key to the near-term outlook for the global economy.

Another important observation that I think partly explains why central bankers have such a poor recent economic forecasting record is that the models they rely on have failed to properly calibrate the relationship between official interest rates and economic growth. In particular, they have failed to fully explain the sensitivity of the household sector to policy rates. This is especially evident in the UK, where, as a result of regulation, an ageing society and the changing nature of the mortgage market, household deposits now significantly exceed loans (by £350bn), and in the mortgage market, 86% of lending is now on fixed rates, typically for five years. In the US, 92% of mortgage lending is on fixed rates, typically for 30 years.

Policymakers are also grappling with the implications of a significant increase in international trade tension, especially between China, the US and the EU. These are complicated issues prompted by claims of unfair competition and by a desire to protect key industries, but their long-term economic implications are not yet clear. Geopolitical challenges are also a key consideration, especially in relation to sensitive technologies and defence applications. In general terms, economic theory suggests trade barriers detract from wealth generation and adversely affect consumer incomes, and in the long term, all economies involved are worse off.

Global economic outlook

The IMF and the OECD are forecasting similar growth rates for the world economy in 2024, at about 3.2%, and in 2025, at about 3.4%. Both organisations highlight the same issues constraining the world economy, namely the lagged effects of high inflation and the slow normalisation of monetary policy, the military conflicts in Ukraine and the Middle East, and escalating trade tensions, principally between China, the US, and the EU.

Both organisations highlight that these growth rates are below the average of the decade before the financial crisis but go on to suggest that they are close to the currently estimated growth potential across advanced and emerging economies.

Below are the OECD’s individual country forecasts for 2024 and 2025 for the G20.

As you can see, the largest emerging economies, India and Indonesia, are leading the way, and according to these forecasts, the Euro area, Japan, and the UK are the developed economy laggards.

In general, I do not disagree with the overall global picture painted by these organisations. As I have already mentioned, I am not sufficiently well qualified to argue with the detailed forecasts for many of the individual countries, especially the emerging economies. However, I will highlight below where my views differ from the consensus represented by these two organisations. I will also make a few comments about why I have a different view and what the risks might be going forward, both to the upside and the downside.

The US economy

Both the IMF and the OECD see growth slowing in the US in 2025 to below 2%. I am not so bearish, although I do see growth slowing from 2024’s 2.6%. The post-pandemic period in the US has been characterised by relatively strong consumption-led growth, which has been supported by a generally strong labour market (wage growth and rising employment) and by an erosion of household savings. Although it is unrealistic to see any further falls in consumer saving, I do see falling inflation and interest rates alongside a continuing robust labour market as the key support for the economy in 2025. My guess is that the outcome will be better than that of the two leading forecasters, and that the economy will deliver 2.1% growth in 2025.

There are risks both to the upside and the downside. The FED is unlikely to deviate from its cautious path on interest rate reductions unless the economy weakens more than I expect. In this case, rates will be cut more aggressively, so I think the downside risks, barring something unforecastable, are well contained. Risks to the upside are linked to the election outcome in November. If Trump wins, I expect his tax-cutting agenda will lead to higher growth in 2025 but offset to some extent by the expected increase in tariffs. My guess is that although Trump will use anti-China rhetoric in the election, he will be keen to “do a deal” with President Xi on trade if he wins.

The UK economy

Although of limited relevance to the global economic outcome, regular readers will know that I have a significantly different growth forecast for the UK economy. Both the IMF and the OECD see growth in the UK in 2024 at 0.7% and 0.4%, respectively. Both are too low. I forecast that growth will be close to 1.5%. For 2025, again, both organisations are way too bearish. The IMF expects growth of 1.5% in the UK and the OECD is forecasting only 1%. My forecast is for growth of about 2.5%. I expect a strong labour market with rising levels of employment complemented by strong real wage growth and lower taxes and energy prices to be the main drivers of strong household spending growth. If current, very high levels of consumer saving were to fall, my growth expectations would rise further.

My guess is that the risks are to the upside, not the downside, despite what the newly elected government has been saying about the state of the UK economy. Following the significant falls in inflation (back to target), policy rates in the UK will fall further over the next 18 months, which will provide further assistance to the domestic economy and especially to the housing market. If I am right, growth might even exceed the 2.5% level in 2025.

The rest of the G7

Although I do not disagree with the IMF or OECD’s forecasts for the EU area, Japan and Canada, I think the risks are also to the upside. This is because I think both organisations may have underestimated the boost to consumer confidence and spending that will come from lower inflation and interest rates, which are now falling across the world (apart from Japan). The Jackson Hole meeting of central bankers earlier in the Autumn highlighted their cautious approach to rate reductions, but the direction of travel is clear, and the stimulus to global consumers and asset prices may have been underestimated in 2025 and beyond.

China

The IMF and OECD’s expectations for the Chinese economy in 2024 and 2025 seem reasonable to me. Both organisations see growth slowing to 4.5% in 2025 as the economy continues its gradual recovery from the pandemic, but neither expects growth to achieve the 5% target. Both organisations will also have to revisit their forecasts in the wake of the recently announced stimulus measures. Nevertheless, this is slower growth than policymakers would like to see. Ultimately, the shift from an infrastructure and property investment-led growth strategy to one led by exports and manufacturing is proving more difficult than the leadership may have anticipated. Ultimately, consistently delivering the growth target of 5% will require China’s consumers to have the confidence to save less and spend more.

The legacy of excessive construction-linked debt, overcapacity and weak pricing in the property market have had important and enduring effects on the household sector. The adverse wealth effects from falling property prices and an ageing population will be hard for policymakers to offset, and both will naturally constrain consumption growth. Offsetting this is growth in manufacturing and exports, which, of course, makes trade issues and tariffs key to the near-term outlook for Chinese growth. Again, my guess is that despite the rhetoric, both the new US administration (in January 2025) and the Chinese leadership will be keen not to let this potential risk to global growth and the economic well-being of both countries deteriorate even further. The same goes for the political leadership of the EU despite the latest round of tariffs imposed on automotive exports from China. Counterintuitively, maybe the biggest surprise in 2025 might be a reversal in escalating trade tension as the new US president looks for a trade deal with President Xi.

The new monetary and fiscal policy measures recently announced by the Chinese central bank and government are also clearly very important for the Country’s economic outlook. Many international commentators are sceptical that the measures will be sufficient to deliver the desired outcome, but my guess is that it would be wrong to underestimate the administration’s commitment to the stated targets. Ultimately, if the announced measures are insufficient, more will be announced.

Looking longer term, lower interest rates and a better backdrop for Chinese equity prices (less foreign selling pressure) will help to offset the challenges highlighted above, but the key for me will be the need for policymakers to ensure that deflation does not become endemic in the Chinese economy. The lessons from Japan are all too relevant.

Global equity outlook

The US equity market has continued to lead the world’s developed economy equity markets, and in turn, large US technology stocks have continued to lead the US market higher. The seven biggest stocks in the S&P (Apple, Nvidia, Microsoft, Alphabet, Amazon, Tesla and Meta), all of which are leading technology stocks, now account for over a third of the index. Ten years ago, this number was 14%. These seven stocks accounted for more than half the total S&P gain in 2023 and, at the end of June this year, were up 57% as a portfolio over 12 months. This compares with 25% for the whole S&P 500.

Clearly, this sort of performance and valuation expansion has delivered great returns to investors in these stocks. But, of course, this outcome also creates risk for those investors who, for fear of missing out or who follow passive strategies, are compelled to maintain index positions in these stocks. In my opinion, all are now priced for near perfection, and none of the ratings reflect the reality of competition, the inevitability of slower growth, nor the sort of adverse regulatory outcomes like the recent antitrust judgement handed down by Judge Mehta in the US against Google (Alphabet).

I do not expect a dramatic correction in the valuations of these companies, but I do expect them to underperform the broader index, which, I believe, will be led by the performance of lower-valued, small and medium-sized businesses that tend to perform well when US interest rates decline. Other more lowly valued parts of the market should also do well, including some financial sectors, including banks.

Aside from this shift in market leadership in the US equity market, I also believe that there are compelling valuation attractions that support the China and Hong Kong equity markets despite the broader domestic economic challenges. In Europe, the UK equity market looks to me to be especially attractive after a very long period of underperformance. Equity valuations across this market are extremely low by comparison with history and with international peers and look especially attractive given the growth outperformance I expect to see from the economy in 2025.

Government bond markets and currencies

In general, I am more positive about government bond markets that will be supported by lower inflation and declining policy rates, where there are also higher starting yields. I therefore prefer the US and UK over the EU and Japan.

Although these are not especially strongly held views, given my economic growth and interest rate expectations, I believe the US Dollar will tend to be weaker against a basket of international currencies. Equally, I expect the Yen, RMB, and Sterling to be broadly stronger but not dramatically so.

Summary

The global economy is performing reasonably well and has recovered remarkably quickly from the challenges posed by the pandemic and the global inflation spike that followed the outbreak of war in Ukraine. My view is that despite the ongoing challenges of trade disputes and military confrontations in Eastern Europe and the Middle East, the global economy will be supported by easing monetary policy and a generally resilient household sector across the developed economies of Europe and the US. For the next 18 months at least, I see a relatively benign global economic backdrop playing out, which could be extended if inflation remains low and interest rates fall back to more normal levels, which I expect them to do.

The biggest delta between consensus and my own views is in the context of the outlook for the US and UK economies. I am more optimistic about the US economy in 2025, where I think growth will be above 2%. However, the biggest difference concerns the UK economy, where consensus appears yet again to be way too cautious both for this year and, more significantly, for 2025.

The global economic outlook is a relatively benign one for the world’s equity markets, which have generally performed well in 2024, most notably in the US, where the NASDAQ is up over 18% and the S&P500 over 17% year to date.