About the author: Nathan Sheets is global chief economist at Citi Research.
A year ago, we expected the global economy to be facing a sharp slowdown in growth and “rolling recessions” in all major economies. We expected global monetary tightening, coupled with headwinds from the gas shock in Europe, to put downward pressure on spending.
But the global economy has defied the laws of economic gravity. Global growth exceeded our expectations last year as consumers simply refused to stop spending. U.S. growth delivered a particularly big upside surprise, with real growth of 2.5% for the year as the economy fended off the impact of the Federal Reserve's interest rate hikes. There were similar surprises in Mexico and Brazil. Although overall growth in the euro area has been poor, service-intensive countries in the south – such as Spain, Portugal and Greece – appear to be recording solid growth of 2 to 2½%. All in all, global growth showed a solid, trend-oriented development.
The markets have enthusiastically received this positive development and the S&P 500 recently reached an all-time high. However, as an economist and practitioner of “dark science,” I continue to see some reasons for concern.
First, many of the lagged effects of tighter monetary policy are still in the pipeline. Countries where interest rates on existing mortgages are adjusting quickly have already felt the blow. A prominent example is Sweden, which fell into recession in the third quarter. But other countries such as the United States will also experience increasing reluctance as higher interest rates and tighter credit conditions continue to take hold. Even if the Fed and other central banks begin cutting rates later this year, these headwinds are unlikely to reverse.
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Second, the global consumer should take a breather in the coming year. Post-pandemic, consumers sought to replace service experiences lost during the pandemic. However, this increase in services spending now appears to be largely complete and the pace of services spending is likely to moderate.
This slowdown in service spending is also likely to lead to an easing of labor markets and a moderation in wage increases. This slowdown will slow global growth, but more importantly, it will also help mitigate global inflation. Central banks are not targeting higher unemployment rates, but history suggests that easing labor markets may be necessary to sustainably reduce inflation to target.
Third, there are significant geopolitical challenges at play. The war between Russia and Ukraine is entering its third year. More recently, tensions in the Middle East have disrupted global shipping routes, resulting in longer transit times and higher shipping costs. The result is increased pressure on goods prices and global supply chains. So far, the oil market has coped surprisingly well with the pressures in the region, but the risks of abrupt price increases are also increasing.
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In addition, there are literally dozens of national elections coming up next year that will determine the economic policies and geopolitical realities of the coming years. The focus will undoubtedly be on the US presidential election. The US electorate remains deeply divided and the election campaign will be loud, intense and bitter. The ups and downs of political developments are likely to lead to market volatility, especially in the second half of the year.
Finally, the global manufacturing sector has weakened in the post-pandemic period as consumers have spent heavily on services. With service spending expected to decline, the manufacturing sector could see a boost. Nevertheless, the prospects remain bleak. There have been some signs of life in the goods sector in the US and Asia over the past year, but this momentum has never expanded or fully sustained. This problem will be crucial for large manufacturing-intensive countries such as Germany and China.
For all of these reasons, we expect the global economy to experience a broad slowdown this year, with essentially all major economies lagging behind last year's pace. Countries that posted relatively strong performances in 2023 (including China and India) are expected to slow somewhat. Countries with weak growth (including Germany, the UK and Sweden) are likely to remain weak. And countries that experienced positive surprises (including the US, Mexico and Spain) are likely to see growth slow.
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If there is an upside, it is that this slowdown in global growth should support central banks' efforts to reduce inflation and create scope for interest rate cuts later this year.
Bottom line: Last year we failed to fully appreciate the deep-rooted resilience of the global consumer. And perhaps we are guilty of making the same mistake again. But one of the basic laws of both biology and economics is that trees don't grow into the sky. And the practical consequence of this is that if something seems too good to be true, it probably is.
Op-eds like this one are written by writers outside of Barron's and MarketWatch newsrooms. They reflect the perspective and opinions of the authors. Send comment suggestions and other feedback to [email protected].
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