Global economic outlook: Rates

Central banks in developed economies have essentially ended their rate hike campaigns and are moving to shape expectations for synchronized rate cuts that should begin in the first half of 2024.

With core inflation easing around the world, the timing and magnitude of those rate cuts will most likely be the difference between another sluggish year of growth and a year that lays the groundwork for a more robust 2025.

While sticky inflation in the service sector will continue to shape central bank rhetoric and policy, tighter financial conditions will in our estimation restrain overall economic activity this year. Such a tightening will reduce the probability of a resurgence of inflation.

The paths to policy easing remain clear. A rise in unemployment will almost certainly result in a near-term easing by global central banks while a continued cooling in inflation will create the conditions for cuts in the second quarter.

We think that the downside risks to growth in Canada, the European Union and the UK will most likely spur their monetary authorities to act first, before the U.S. moves to reduce its policy rate around midyear.

In Japan, the coming year will see yield curve control and negative interest rates come to an end as capital flows back into Japan to take advantage of positive yields on Japanese government bonds for the first time in years.

Given China’s breakout of deflation and deterioration in growth, that country’s central bank will remain quite accommodative and seek to work with the fiscal authority to spur growth. 

Risks around the outlook

The major risk to the rates outlook is twofold:

• Delay by central banks. Given the stalling of economic activity in the UK, the European Union and Canada, we would expect that those central banks will move to reduce their policy rates by the middle of 2024, probably in advance of the Federal Reserve, which we believe will kick off approximately 100 basis points of policy rate reductions.
• China debt contagion. China’s deleveraging crisis will become a global event as Beijing tries to export its surplus production and deflation via the trade channel in 2024. Once a debt and deleveraging crisis starts, it typically takes seven to 10 years to finish. We think the Chinese episode will be no different.

An attempt by China to export the burden of its internal economic adjustment will almost certainly happen alongside the depreciation of its currency, which will inflame trade tensions.

In short, as Beijing works to reduce its household, corporate and government debt, it is compelling banks to redirect investment capital to domestic manufacturers. Those firms can ramp up production, but they do not have a healthy domestic sector to mop up the excess supply of goods that will follow.

As a result, China’s manufacturing firms will almost certainly turn to the global economy to absorb that increase in supply.

China’s trade partners will then have to accept a lesser share of manufacturing in their own domestic economies, leading to an increase in industrial policy and other protectionist measures.

This, we think, is the major risk and will be part of the global economic narrative. More to come on this in the near term.