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World outlook optimistic but with uncertainties

By Jim Reid/David Folkerts-Landau | China Daily | Updated: 2024-06-21 06:34
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A cargo ship docks at Qingdao Port in Qingdao, East China's Shandong province, in this file photo. [Photo/Xinhua]

As we approach the half-way mark of 2024, the global economic outlook is looking increasingly positive. A soft landing for the US economy is a strong possibility now that it has proved resilient against the rapid rate hikes of 2022-23. Growth is looking more positive in the European Union too, although it appears to be more of a cyclical rather than a structural upswing.

In Asia, China's growth has surprised on the upside in the first quarter of this year, while Japan's growth is likely to stay above potential. This will help support risk assets in the near term as well, with our (Deutsche Bank's) strategists seeing the S&P 500 rising to 5,500 by year-end, as credit spreads should grind tighter over the coming months.

Many obstacles to navigate

But there are plenty of obstacles to navigate. The global economy is still experiencing the lagged effects of tighter monetary policy while quantitative tightening continues. Inflation has come down, but both headline and core inflation are still above target in several major economies, including the United States and the eurozone. The rest of 2024 will also see elections in many countries, with results expected from France, the United Kingdom and the US.The results of the US election will be in particular focus, with the potential for major implications for the global trading system.

Moreover, the elections will be held against the backdrop of several geopolitical hotspots, including in the Middle East and Ukraine. Indeed, given the surprises of recent years, it's hard to imagine there won't be at least some economic shock in the next couple of years.

Looking at the different regions, our US economists continue to anticipate a soft landing with GDP growth of about 2.4 percent this year (close to the 2023 level) and about 2.2 percent in 2025 and 2026. Inflation in the US is running hot but our economists believe that rent prices will ultimately aid the disinflation process and allow the US Federal Reserve to cut rates in December. The economists see the start of a 75 basis-point mid-cycle adjustment by mid-2025, before edging toward neutral (3.75-4 percent) by 2026.

The greatest uncertainty, however, is the US presidential election in November, especially given how close it looks set to be. It's unlikely there will be any move to reduce the deficit, and for now it's a reasonable assumption that it will remain around 6.5 percent of GDP over the next five years, regardless of which party's candidate wins the presidential election.

However, the nature of that budget deficit could well change after the election, as Republicans would pursue more tax reductions while Democrats would prefer increasing spending, possibly combined with a lapse of tax cuts on upper-income households and some increase in the corporate tax rate. The potential outcomes will depend not just on the new president, but also on which party controls the two chambers in Congress.

For the EU, our economists have made substantial upgrades, raising the eurozone's 2024 GDP forecast by half a point to 0.9 percent. After the stagnation in 2022-23, the European Union's GDP started growing again in the first quarter of this year, with external demand as the driver. However, this optimism is more cyclical than structural. Our economists are not extrapolating the faster 2024 momentum into 2025, and forecast a 1.5 percent GDP growth.

With wage growth peaking, our economists continue to believe inflation would converge back to target in 2025, and expect three 25 basis-point rate cuts by the European Central Bank in 2024, with the risk now skewing toward two.

China's growth forecast raised to 5.2 percent

Turning to Asia, in April our economists raised the forecast for China's growth in 2024 by 0.5 percentage point to 5.2 percent after a stronger-than-expected first quarter. The economic outlook has not changed much since then; growth in the near term will be supported by a continued recovery in exports and a healthy increase in fiscal spending. Beyond that, growth will likely slow to 4.5 percent in 2025, with the economists expecting the People's Bank of China to cut the policy rate twice this year for a total of 20 basis points.

In Japan, our economists expect growth to remain above potential for the next two years. Japan's external environment is improving, and its domestic demand is expected to remain steady, supported by accelerating wage hikes. Although the underlying inflation trend will continue to decelerate, it is likely to rise again as wage increases are passed through to sales prices. Our forecast for Bank of Japan is more hawkish than the market with a hike to 0.25 percent in July, 0.5 percent in December, followed by further 25 basis-point hikes in the third quarter of 2025 and the first quarter of 2026.

When it comes to our market forecast, a significant shift in fiscal policy could have a material impact on the rates outlook in the longer term. From an economic perspective, there is a strong case for easier fiscal policy in the EU to deal with the strategic geopolitical challenges ahead. From a political perspective, the current fiscal construct in the eurozone in general and Germany in particular are hurdles to easier fiscal policy.

On the other hand, the lack of tighter fiscal policy even under a divided government in the US right now indicates increased political tolerance for fiscal spending. The resolution to the conflict between economic logic and the political environment will ultimately be key to determining the outlook for monetary policy and rates in the years ahead.

Bullish view on dollar and foreign exchange

In foreign exchange, our strategists' bullish outlook on both the US dollar and foreign exchange continues. More than half of the world's developed market central banks, including the Fed and the ECB, are expected to have identical easing cycles leading into 2025-26. As long as the US dollar remains a high yielder, the strategists continue to see a potential Fed easing cycle as a bark with no bite for the dollar. And with global growth holding up so far, the dollar can continue doing well, with a break below 1.05 for euro/US dollar being more likely than a sustained move above 1.10.

In Japan, our economists don't see the stars aligning for a stronger yen. Intervention has been aimed at slowing the move rather than defending the levels, and underlying inflation can still afford a gradualist Bank of Japan in the economists' opinion.

Japan's external balance is not responding to a weak yen. And the broader basic balance remains negative, with foreign direct investment and portfolio outflows continuing. A big shift toward repatriation dynamics is the biggest potential positive catalyst for the yen, so our economists are keeping an eye on the upcoming government pension investment fund portfolio review later this year.

In equities, our strategists continue to be constructive as they feel macro upgrades have further to go. While the macro consensus has dropped persistent US recession calls, it has remained below actual growth for the last seven quarters. The strategists' forecasts point to a 2024 year-ending target of 5,500 for the S&P 500 (current 5,235) and 540 for the Stoxx 600(current 518).

Overall, our economists and strategists are relatively optimistic. Even in this bullish year so far, the narrative has changed many times, with futures going from pricing in almost seven Fed cuts in January to falling to just over one as we go to print. This back and forth in rate expectations, where the market has been too dovish, has been a constant narrative for the last couple of years and suggests that this cycle is struggling to conform to models the market relies on. Given that backdrop, it does feel that it pays to be flexible and to have some contingencies for the unexpected.

Jim Reid is Deutsche Bank's global head of economics and thematic research; and David Folkerts-Landau is the bank's chief economist and global head of research. The views don't necessarily reflect those of China Daily.

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