Ending the 2023 With A Bang

By the end of 2022, the year-over-year change in the Personal Consumption Expenditure index was 5.9 percent and the Core PCE, the Fed’s preferred inflation gauge which excluded food and energy, inflated by 4.4 percent. The unemployment rate was 3.5 percent, and the real GDP growth was 2.6 percent. The Fed Funds rate ended the year 2022 at 4.25-4.5 percent following seven hikes over the past year.

Better Than Expected

In their last economic projection for 2022, the Federal Reserve painted a picture of a slowing economy, falling inflation, and tightening financial conditions for 2023. The FOMC pegged the median real GDP growth estimates for 2023 to be around 0.5 percent with the central tendency – excluding the three highest and three lowest projections – to be between 0.4-1.0 percent. It also put the median estimate for the unemployment rate to be 4.6, the PCE inflation to be 3.1, and the Core PCE inflation to be 3.5 percent. The central tendency for these measures was estimated to be 4.4-4.7, 2.9-3.5, and 3.2-3.7 percentages respectively. The committee also put the median estimate for the 2023 year-end Fed Fund rate to be 5.1 percent.

So far, the US economy is saying that the 2022 year-end FOMC expectations were a tad pessimistic. The latest PCE report – released on 30 November 2023 for October – put the PCE inflation for 2023 to be 3.0, and the Core PCE to be 3.5 percent. The final government employment report for 2023 put the unemployment rate to be 3.7 for November. The latest estimate – on December 14, 2023 – of Atlanta Fed’s GDPNow indicator is 2.6 percent. The Fed Funds rate is going to end the year within the 5.25-5.5 percent range.

Equity Markets Get their Mojo Back

The US stock market has also staged a much better performance than estimated. At the end of 2022, Wall Street’s estimates for the S&P 500 ranged between 3,400 to 4,900 with a majority of firms staying between 4,000 and 4,5000. By mid-December, it is quite likely that the index will settle above 4,700, which would be more than 22 percent from 2022.

The developed markets have generally outperformed the emerging and developing markets. The performing index of 2023 is the NASDAQ Composite followed by Istanbul’s BIST 100 index. The UK’s FTSE 100 is the sick child of Europe and Shanghai, Hong Kong, Singapore, and Malaysia are its counterparts in Asia. The dollar index slipped in 2023 but it was up for the year at the end of September. The US Treasury yields were up for 2023, but like the dollar index, they have declined sharply since October. The same is the case for crude oil and natural gas. Gold has had a stellar year. Copper is up for the year though for most of the year it declined after advancing significantly in the first few weeks of the year. The commodities in general had a mixed year. Palladium, Platinum, Corn, Wheat, Soybean, and Cotton prices declined in 2023 but the prices of Sugar, Coffee, Cocoa, and Live Cattle rose.

Outlook for 2024

The FOMC’s December meeting expects the median real GDP growth rate for 2023 to be 2.6 versus 2.1 percent which it projected in September. The year-end unemployment rate estimates remain the same at 3.8 percent, the PCE inflation forecast is down to 2.8 from 3.3 percent, and the Core PCE Inflation is down to 3.2 from 3.7 percent. The Fed Funds rate is at 5.25-5.5 percent. The FOMC’s economic projections for 2024 are, again, a slowing economy with tamer inflation. The FOMC expects the real GDP to slow to 1.4 percent in 2024, the unemployment to rise to 4.1 percent, the PCE inflation, and the Core PCE inflation to decline to 2.4 percent. It also expects the Fed Funds rate to be between 4.5-4.75 percent range or three rate cuts of 25 basis points.

Global Economy – Sluggish

In its October 2023 update of the World Economic Outlook, the IMF says that despite the resilience shown by the world economy in 2023, the overall economic activities fall short of their pre-pandemic glide path. The shortfall is more pronounced in emerging and developing economies with widening divergence among regions. The IMF blames the sluggishness to:

• Long-term consequences of the pandemic, the war in Ukraine, and increasing geoeconomic fragmentation.
• Cyclic factors including tightening monetary policy to reduce inflation, withdrawal of fiscal support to reign in rising debt, and extreme weather events.

The global growth is forecasted to slow to 3.0 percent in 2023 from 3.5 percent in 2022. It is expected to further slow to 2.9 percent in 2024. For comparison, the historical (2000-19) average is 3.8 percent. The October forecast for 2024 is lower by 0.1 percent from the July 2023 forecast. The global growth forecast over the medium term, of 3.1 percent, is at its lowest in decades, with weaker prospects for catchup.

The advanced economies are expected to slow down from 2.6 percent in 2022 to 1.5 percent in 2023 and 1.4 percent in 2024. The stronger-than-expected US growth is more than compensated by the weaker-than-expected euro area growth.

The slowdown in emerging markets and developing economies is expected to be moderate. Their growth is set to decline from 4.1 percent in 2022 to 4.0 percent in both 2023 and 2024. The figure for 2024 is revised downward due to the property sector crisis in China.

Global inflation is steadily declining – from 8.7 percent in 2022 to 6.9 percent in 2023 and 5.8 percent in 2024. The forecasts for 2023 and 2024 are revised up by 0.1 percent and 0.6 percentage points and are not expected to return to target until 2025 in most cases.

Widening Growth Divergence

The IMF’s World Economic Outlook notes widening growth divergence across regions. After the initial rebound from the pandemic-induced collapse, global recovery has followed diverging trends in output, consumption, and labor sector performances, though not in business investment area.

The US is clearly the leader. Its GDP is expected to exceed its pre-pandemic path in 2023. The euro area has recovered though it is still 2.2 percent below pre-pandemic projections. The war in Ukraine is a major contributor to this underperformance. The Chinese economy is underperforming by 4.2 percent from pre-pandemic predictions, due to the property sector crisis and a late ending of the Covid-related closures.

The recovery by other emerging markets and developing economies is weaker by an average of 6.5 percent. The main culprits for this are higher interest rates and depreciated currencies. The overall global output is lower by 3.4 percent from the pre-pandemic projections.

The tale of consumption recovery is similar. The private consumption has recovered fastest in the developed markets owing to earlier reopening, faster access to vaccines, substantial policy stimulus, and greater feasibility of remote work. The household consumption in these markets is now broadly back to pre-pandemic trends.

The US led the world in this area with larger fiscal support earlier in the pandemic. It also spent the associated savings from these transfers. The euro area is lagging behind the US hamstrung by the rising energy costs due to the war in Ukraine. The consumption shortfall is greater in emerging markets, especially China, which suffered more due to tighter and longer mobility restrictions during the pandemic.

The divergences in the labor market more-or-less mirror the divergence in output and consumption. The advanced economies are on track to exceed their pre-pandemic employment and labor participation rates but the emerging markets and developing economies are significantly below their pre-pandemic trajectories. The euro area is the leader followed by the US, which may be due to its stronger worker-retention programs.

Compared to output, consumption, and the labor sector, the investment has fallen short across regions in equal measure. The businesses are leery of expansion and risk-taking due to rising interest rates, expiring fiscal support, stricter lending standards, tightening financial conditions, subdued demand, and growing geoeconomic fragmentation. The overall investment level is 3 percent to 10 percent lower across regions compared to per-pandemic estimates.

Salient Points of the Global Economy [1]

1. The recovery from the shocks of 2020-22 is ongoing. The resilient start of 2023 is showing signs of a slowdown.
2. World returning to normalcy following Covid-19. The pressure on the global supply chain is easing and there are fewer incidences of the virus attacks.
3. The cumulating access savings in the advanced economies are tapering and falling off. The depletion is greater in the US than in the euro area. This will result in fewer resources for consumers.
4. Tourism has returned to normal, though the pace of recovery has slowed.
5. Slower growth momentum ahead. The leading indicators of services are pointing a weaker growth or declining output.
6. The manufacturing sector is demonstrating a wide-ranging slowdown or contraction, with declines in industrial production, investment, and international trade in goods.
7. Consumer and business confidence is still low.
8. China’s growth is slower. The country’s growth momentum following the reopening in early 2023 has fizzled out. Its GDP growth slowed from 8.9 percent in the first quarter of 2023 to 4.0 percent in the second quarter. The inflation fell to 0.2 percent in the second quarter of 2023. High-frequency indicators suggest further weakness with the property sector going into a crisis.
9. The inflation has been falling but the war has not yet won. The global headline inflation has more than halved to 5.3 percent from a peak of 11.6 percent in the second quarter of 2022. The decline is mostly driven by falling energy prices and to a lesser extent by lower food prices.
10. The labor markets are still tight but easing as indicated by the decline in the ratio of vacancies to the number of employed.
11. There is little indication that the wage-price spiral – in which prices and wages accelerate at the same time for a sustained period – is taking hold in advanced economies. The wages at the bottom of the distribution have risen faster than average, compressing the wage distribution.
12. The company profits have increased strongly over the past two years, with wages having risen more slowly than prices.
13. The monetary policy has mostly tightened across the world. The signs are that the tighter monetary policy has started to work through the financial system restricting access to credit and resulting in lower investment demand.
14. House prices have slowed or are reversing.
15. The overall global Outlook is stable but slow. The medium-term growth prospects remain the lowest in decades. The middle- and lower-income countries face resistance on their march toward higher living standards.

Risks to the Outlook

The IMF predicts a more balanced distribution of risks for global growth. Inflation has come down from a multi-year high and is on a gradual path to normal levels. The US debt ceiling tensions and the Swiss banking scare have subsided.

Upside Risks

• Inflation falls faster than expected. A factor that may contribute to this is the stronger-than-expected pass-through from lower energy prices or compression of profit margins to absorb cost increases.
• Domestic demand recovers at a faster pace. In many economies, the excess savings accumulated during the pandemic has not been drained yet.
• Stronger policy support in China than anticipated.
• Faster recovery of private investment.
• More impactful technological breakthroughs, e.g., in artificial intelligence or electric vehicle batteries.

Downside Risks

• China’s economic growth slows further. The extent of the slowdown will depend upon policy response. The pace of growth – slower or faster – will have an impact on China’s trading partners’ growth too.
• The commodity prices could become more volatile amid climate and geo-political shocks.
• The underlying inflation persists longer than expected.
• Financial market expectations revised down. The financial markets have adjusted their expectations upward regarding the monetary policy. However, new inflation surprises or some other event may disrupt the glide paths of the central banks resulting in the financial markets revising their expectations lower.
• Debt distress increases. The global financial conditions have eased since the March 2023 banking stress episode, but the lending standards have tightened, and the loan demand has declined. The borrowing costs, especially in emerging markets and developing economies, remain high.
• Geoeconomic fragmentation intensifies, hampering multilateral cooperation. The war in Ukraine is dividing the world economy in blocks, which could hamper trade, and the cross-border movements of capital, technology, workers, and payments.

The Final Word

The global economy in 2023 showed robust resilience and performed better than predicted at the end of 2022. The global growth prospects for 2024 are stable though the pace may slow down from that in 2023. The global equity markets have bounced handsomely from the lows reached in October 2023, in many cases to new highs. The prospects of their momentum spillover are substantial in the early months of 2024.