In our ‘2023 Mid-year Investment Outlook’, we examined central bank fiscal tightening and China’s uneven post-pandemic recovery. Based on our analysis, it looks like the global economy might dodge a ‘hard landing’.
Inflation seems likely to pull back in the latter half of this year. We outline three potential scenarios in the report, and our base case points to the possibility of a relatively short and mild economic slowdown, which we refer to as a ‘bumpy landing’.
Such a scenario could materialize in the US if inflation continues to moderate and monetary policy tightening ends soon, followed by a recovery. Early indications suggest that the eurozone and UK could follow a pattern similar to the US but with a lag. A variety of forces have helped sustain European economic momentum so far in 2023, but tightening financial conditions will likely weigh on credit growth, helping to reduce inflationary pressures - but also causing a material economic slowdown.
China’s bumpy take-off
The relaxation of COVID-19 restrictions has driven a meaningful but less rapid than expected recovery in Chinese growth. While services activity has remained relatively strong, slowing global growth has meant softer manufacturing activity.
China’s trajectory – while difficult to predict with certainty – points towards the potential for improving growth if adequate targeted stimulus is provided. Inflation in China is well-anchored, and monetary policy remains accommodative.
The good news is that emerging markets have significant growth potential. Southeast Asian economies in particular are benefiting from the trend among some companies to diversify global supply chains. India will likely continue to be a major driver for global growth, helped by demographics. Early indications point towards a mixed near-term outlook for other emerging market economies.
US versus European outlook
While the outlook remains that the US Federal Reserve is at or near its terminal rate, the outlook in the UK and Europe is less certain. Persistently high inflation in the EU and UK has caused rates to move higher than initially anticipated (particularly in the UK). Tightening credit conditions are helping to reduce inflationary pressures but also negatively impacting growth.
The need for future rate hikes is unlikely in the US and uncertain in the eurozone, although the Bank of England (BoE) seems more likely to continue hiking. The ECB terminal rate is likely to be lower than that of the US.
Three risk-based scenarios
While the base scenario described above indicates a bumpy landing, there are two other potential scenarios. A hard landing remains a possibility, in which global growth is hit harder by the lagged effects of aggressive central bank tightening. Conversely, a smooth landing is an upside scenario in which monetary policy impacts growth less than expected, and the global economy is relatively unscathed.
With strong services performance but weak manufacturing output, China’s impact remains uncertain. Policymakers may also act to reinvigorate the Chinese property market and counter demographic headwinds.
The outlook also points to key risks that remain elevated, including the potential for financial accidents such as the failure of several banks in the first-half of 2023. Such risks raise the probability that central banks will likely have to pivot to an easing regime more quickly, perhaps leading to an eventual transition to a recovery regime.
Risks facing US commercial real estate are also noteworthy. Aggressive Fed rate hikes caused a rapid rise in mortgage rates, which along with a broader tightening of credit conditions, exerted downward pressure on commercial real estate prices.
While continued downward pressure on real estate prices in the near term is expected, commercial mortgage rates may lower, and credit conditions may improve by later in 2024, at which time a significant portion of commercial real estate loans will begin to mature and need to be refinanced.
While such risks remain a concern, the overall global picture suggests that a hard landing will be avoided. Instead, given that disinflation is underway and policy rates are peaking, a modest economic downturn is more likely. Markets are likely to soon look past this slowdown and begin to discount a future global economic recovery.
