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The Decisive Episode 9: Global macroeconomic themes

 

Kristen Hallam

You're listening to The Decisive Podcast: Insights and Analysis to Empower Confident Decision-Making.

Hello. I'm Kristen Hallam, Lead Content Strategist for Global Intelligence and Analytics and host of the Decisive Podcast.

Recent economic data releases have sparked turmoil in financial markets around the globe. S&P Global Market Intelligence's interpretation of this recent data suggests that fears of an imminent U.S. recession and related expectations of aggressive policy rate cuts are overdone.

To be clear, our economists are not ruling out a U.S. recession. That will remain a risk with financial conditions still restrictive. But the evidence to support it occurring imminently looks unconvincing at this stage.

As markets settle, we offer you this excerpt from our July 11 webcast, in which our global economist reflected on key macroeconomic themes as we move through the second half of 2024. We hope you -- this commentary valuable in navigating the period ahead.

Ken Wattret

Hello, everyone. I'm Ken Wattret, Global Economist at S&P Global Market Intelligence. We've just passed the halfway point of the year, so it's a good time to take stock. And I'd like to focus on 3 key aspects of our forecasts.

The first is the decoupling of the U.S. and Western European economies. We continue to expect the U.S. economy to cool down while Western Europe is emerging from recession or stagnation. Now in line with our expectations, we expected that some of the adverse effects of the conflict in Ukraine would diminish, and that would filter through to an improvement in economic conditions in many parts of Europe, which we've seen.

And that's very much evident in our PMI data, they've shown across-the-board improvements compared to autumn of last year. And GDP figures that we've had for the first quarter of the year, including in the U.K. particularly, have also shown, in many cases, a marked pickup.

Now our PMI numbers have also been flagging an improvement in global trade prospects for several months now, and that's benefiting many of the economies in Western Europe which are highly trade-sensitive. Now this all being said, we think the economic expansions in most of Western Europe will remain rather gradual. That's indicated by the levels of most of the PMIs in the region, Spain in this case being a notable exception.

Now as for the U.S., we've been expecting growth to cool off, as mentioned. And the evidence has been accumulating in that direction recently. We see it in the recent data on state and local construction. We see it in spending on manufacturing structures. We've also seen it in final sales to private domestic purchasers. The latter slowed appreciably in the first quarter of the year, and our tracking estimate produced by our U.S. macro team is pointing to more of the same in the second quarter.

So we expect that evidence of gradual slowdown to continue, reflecting the diminishing effect of various tailwinds and some headwinds, including tighter bank lending standards, the strong dollar and also less growth-friendly fiscal policy.

Now the second key theme is moderating inflationary pressures, where the news has been somewhat mixed. Consumer price inflation rates have largely continued to trend downwards, although they have proved to be somewhat stickier than expected, particularly in certain areas. And that's vividly illustrated by comparing our estimates of average core goods and services inflation rates in 5 key economies.

Now core goods inflation is typically more sensitive to global factors like commodity price trends, supply chain conditions, and that inflation rate has tumbled. According to our calculations, it turned negative for the first time since early 2020 in these 5 economies on aggregate, and it's fallen by around 9 percentage points from its peak back in 2022.

Now in contrast, services inflation, which is less tradable, typically more labor cost-driven and usually more sensitive to domestic economic conditions. That's just been edging downwards. It's heading down, but it's been very gradual so far according to our estimates at the latest data point available, which was for April, it fell to 4.8%. That's about 1.5 percentage points below its peak in 2023 and still well above the rates consistent in the past with central bank inflation targets being met.

Now we're continuing to forecast that services inflation rates will moderate as wage and unit labor cost growth rates decline. But that's a process that's taking some time.

And that leads us to the third theme, which is differences in the timing of monetary policy easing and related consequences. Now if we start there with the Federal Reserve in the U.S., due to persistently elevated core inflation rates, we pushed back our forecast of the initial interest rate reduction to December this year.

Although having said that, recent developments suggest the likelihood of a somewhat earlier move is increasing. Those developments include recent comments from the Fed Chair, Jay Powell, which emphasize not only the improvements in inflation which were becoming apparent, but also the importance of the Fed focusing on both aspects of its mandate. So some focus on the softening in labor market conditions that we've seen.

Now if we continue to see more evidence of both of those things, moderating underlying inflation pressure and the cooling of labor market conditions, we think September's FOMC meeting comes into play for the first cut in Fed rates.

Although it's worth emphasizing that scenario is pretty much priced into futures markets already. They currently discount a close to 80% chance of a 25 basis point Fed cut in September with two 25 basis point cuts fully priced in by the end of the year.

Now of course, what the Fed does matters a lot for what other central banks will do. Many central banks around the world have been constrained by concerns about inflation, and related to that, worries about potential currency depreciation should interest rate differentials move too far into the U.S. dollar's favor.

Now some central banks have already cut interest rates significantly. Indeed, we were predicting last year that in parts of Latin America and emerging Europe, rate cuts would start well ahead of the Fed as their monetary policy responses to the surge in inflation back in 2021 and '22 had been much more prompt and much more substantial.

We'd also been predicting well ahead of time that the ECB would begin to cut interest rates ahead of the Fed. June was our call for a long time. Of course, the ECB delivered on that and has signaled that there is some scope to reduce rates somewhat further before the end of this year. Other central banks in Western Europe have been doing likewise, albeit at slightly different speeds.

Now looking a little further into the future. Our base case remains for a stream of U.S. interest rate reductions in 2025 and '26, opening the door for more widespread central bank easing across the globe.

Now that shift to more accommodative global financial conditions is forecast to provide some support to economic activity, although a return to the ultra-low policy rates that we became used to in advanced economies prior to the pandemic looks very unlikely in our view. And that, in turn, is one of the reasons why we don't expect global growth in the current expansion to reach the heights that we've seen in prior economic cycles.

Now another restraint on economic activity is high debt. And the final point I'll highlight is the need for governments in many of the world's largest economies to take action to bring down their budget deficits.

Financial markets have generally been quite relaxed about these persistent high deficits, but there have been some warning signs recently of a shift in mood. That includes the spike in the OET-bond spread that we saw ahead of the French elections. And we think it's quite likely that we're going to be returning to this topic before long.

Kristen Hallam

Thank you for listening to the Decisive Podcast from S&P Global. Please subscribe and join us for next week's episode. Until then, stay curious and stay informed.