Corporate Meeting

The Economic Outlook for 2024

Friday, January 12, 2024
REUTERS/Hannah Mckay
Speakers

Managing Director and Global Head, Sovereign Credit Management, Citigroup

Chief Economist, EY

Managing Director, Global Macro Research, NWI Management LP

Presider

Adjunct Senior Fellow, Council on Foreign Relations; General Partner and Executive Vice President, America’s Frontier Fund

Corporate Program Virtual Meeting and Renewing America

CREBO-REDIKER: So good morning. And thank you all for joining us for CFR’s webinar on “The Economic Outlook for 2024.” I think we have—we have a whole lot to cover. We’re going to try and cover the global economy and global markets. It’s a lot of territory. And I think, you know, we have a great—a great panel to touch on these topics. We have themes that are going to be discussed that are probably, you know, similar to 2023 about navigating uncertainty and how we see differentiation in the global economy and global markets. And we’ll try and touch each of the U.S., the EU, and intra-EU, Japan, emerging markets. And, importantly, China. And hopefully, we’ll be able to speak about India as well.

We might not have all of our speakers agree with one another, so we want to have a lively conversation. And then we’ll open it up to questions about thirty minutes in. So please start getting your questions for the panel ready. And this is CFR. So we also want to weave in what is less-easily quantifiable—meaning geopolitics and the role of national security and economic policymaking. And because we’re going to have a supercycle of elections, domestic politics are going to weigh heavily in many of the markets, starting with Taiwan’s election tomorrow.

So let me introduce Nehad Chowdhury, who is the managing director and global head of sovereign credit management at Citigroup. We have Gregory Daco, who is the chief economist of Ernst and Young. And Tara Hariharan, who is the managing director and head of global macro research at NWI Management. And I would like to start with Greg on the U.S. economy.

In 2022 we had some pretty grim predictions about what the U.S. would look like in 2023. And the forecast had to recalibrate as the U.S. proved a lot more resilient. So please walk us through what your thoughts are for 2024, both on the macro monetary policy side, fiscal, and particularly because the U.S. has, you know, one of the most consequential elections of this election-year cycle.

DACO: Yeah, absolutely. And thank you. Thank you, Heidi, for that great question.

I think you started it right in highlighting the fact that 2023 was really a year where we saw outright resilience and an outperformance of the global economy relative to consensus expectations, driven in large part by the fact that the U.S. economy outperformed very weak expectations. A lot of forecasters were actually expecting a recession over the course of 2023. The turnout is likely to be growth around 2 ½ percent for this—for last year. So that’s about 2 percentage points higher than it was expected to be.

The key driver behind that, I think, is the labor market resilience. We’ve continued to see a labor market that continues to add a certain number of jobs. That, in turn, has been supportive of income growth and, in turn, consumer spending. So we haven’t seen the type of retrenchment that was once feared. As we focus on 2024, I think there are really five key themes that I want to highlight when it comes to the U.S. economy. The first one is that we’re likely to see sub-trend growth in the U.S. economy, but no recession. I think recession risks are elevated, but we’re not at the point where we’re likely to see a recession over the course of 2024.

And the key reasons why I have this nuanced outlook for the U.S. economy is that there’s going to be this duality of headwinds and tailwinds that fight over each other over the course of the next year. The tail winds are known, right? One of the key tailwinds is the fact—sorry, the headwinds are known. One of the key headwinds that we know of is this idea of cost fatigue. This idea that the cost of everything—whether it’s goods, services, labor, cost of interest rates—is much, much higher than it was before the pandemic. And that is eroding purchasing power for consumers as well as potential investment spending power by business investors.

So it’s that constraint on private sector activity that is likely to linger over the course of this year, because we don’t anticipate a big fallback in price levels. Inflation is moderating, but price levels remain high. The cost of interest rate is also one of the key areas that will constrain economic activity over the course of this year. While we do anticipate some rate cuts, rate levels will remain quite high.

But there are also likely to be tailwinds. I mentioned the fact that we’re not expected retrenchment in the labor market. That should continue to support income growth. And as wage growth remains slightly higher than inflation, that should provide a real income boost to households across the U.S. And at the same time, another important tailwind is going to be the fact that in an environment where inflation is moderating, central banks will be easing monetary policy.

So that brings me to the third theme, which is this idea that inflation is going to be cooling. Disinflation momentum remains quite strong. When you look across the different sectors in the U.S., you have the ideal combo for further disinflation as we navigate through the rest of the year. You have final demand growth that is moderating. You have an environment in which rent disinflation is in the pipeline. You have margin pressures that are easing, as we saw with the most recent PPI data. You have wage growth that is moderating and businesses that are focused on wage growth compression as an avenue to limit costs. And, let’s not forget, the Fed remains quite tight in terms of its monetary policy strategy.

The fourth theme is the fact that we’re going to see central banks pivoting across the world. We’ll talk more about that in a second. But the Fed I think is going to be cautious in the way it pivots with monetary policy. We don’t anticipate that current market pricing, which is about 150 basis points of rate cuts this year, is correct. I think that’s a little excessive given what we’ve just been through in terms of the inflationary backdrop. We think the Fed will be a little bit more cautious, proceeding with an initial rate cut likely in May, with about 100 basis points of rate cuts over the course of this year.

And then the final theme that I think is important to mention, because it’s U.S.-based but also globally based, is that we’re going to be in a year of fiscal consolidation where there’s going to be less appetite for massive fiscal programs. We’re in an election year, as you mentioned in the introduction, in the U.S., and in most places around the world. But we’re also going to be in an environment where we’re geopolitically restrained. Geopolitical risks are likely to continue to affect supply globally, but also in the U.S. And trade disruptions are something that we have to monitor as a potential risk for the U.S. economy.

So overall, growth that is muted, around 1.6 percent for the U.S. economy, but no recession, which is the positive theme. And I think it’s a very nuanced outlook when it comes to one of the major economies in the world.

CREBO-REDIKER: That was a great way to start us off. And I think, you know, one of the things that will be interesting to see Americans don’t seem to be feeling the—sort of the positive and the—you know, the positive influences that you just mentioned. And maybe we can get into to why the American consumer, and particularly middle class, is not actually feeling how good the economy seems to be performing.

But next I want to turn to Tara, to China, which is—you know, which has, you know, in the past been the central driver of growth in the global economy. And we’ve seen, with a lot of—a lot of optimism in 2023 post-COVID, with the reopening, what ended up not being the star performer. In fact, it has struggled even with stimulus. It has a post-COVID slump. It’s suffered from a property crisis, which could in 2024 worsen bank balance sheets and have serious financial ramifications. We’ve seen a fall in investment. And one thing I pay a lot of attention to is youth unemployment, which I think is way underreported as both the data and the story. So I’d love to hear what—you know, what your thoughts are on China. I know you spend a lot of time looking at China. And also, the impact on emerging markets, because there are many spillovers that are related to China in the emerging market space.

HARIHARAN: Thank you so much, Heidi.

So it’s funny you say it. At the end of 2022, I was actually one of the relatively few analysts who argued that Chinese property sector woes and the high local government debt levels would actually temper the enthusiasm around the COVID reopening. And that’s basically what happened, because while growth in 2023 did exceed 5 percent, it’s mainly unfavorable comparisons from the 2022 lockdowns, not really because of robust sentiment. Well-meaning policy easing has also not really worked. We have seen rate cuts and reserve ratio requirement cuts so far, but they really haven’t revived weak demand for mortgages as well as for corporate loans.

In particular, the consumer is very hesitant to borrow, to spend, or to buy homes because the jobs market is weak and, as you mentioned, Heidi, youth employment is very high. Wages are slowing down. And also in the property sector, the very highly indebted developers haven’t even delivered the pre-sold homes that they have promised to buyers. On the trade side as well, the shine has come off of China’s exports. I think we just got trade numbers suggesting that China’s exports fell on a year-on-year basis in 2023.

On the fiscal side, I’d argue maybe that China might be one of the few places in the world that might expand fiscal policy this year. But even the existing fiscal policy expansion done so far hasn’t really boosted growth because the local governments, who are highly indebted, have been told to rein in their to debt and to avoid unprofitable infrastructure projects. And there’s also these ongoing anticorruption probes, which made the local governments even more hesitant to take bold growth positive steps. Private investment is also pretty muted, again, thanks to government crackdowns. If you recall the crackdowns on the private tech giants, and the slogan that Xi had over disorderly expansion of capital needing to be reined in.

And we also have, of course, the geopolitical trends. Worsening U.S.-China competitive tensions are also dampening investment flows into China. In fact, foreign direct investment into China turned negative towards the end of last year. And on top of all of this, China has a deflation problem and not an inflation problem. And a lot of this is due to what we have just discussed, and due to what the authorities themselves termed as insufficient demand. In my opinion, the only encouraging new policy development is low-cost central bank lending, called Pledge Supplementary Lending, that is now going towards trying to boost the supply of affordable homes in the hope that then this will improve property demand and then set up a beneficial growth cycle. But I think this will take time. And so while China may announce an ambitious 2024 growth target of around 5 percent, or even higher, I am very skeptical as to how it is going to be reached at this stage.

In terms of EM also, of course, I would just point out one thing. That China is the elephant in the room as a large creditor to many highly indebted EM countries and at the same time, of course, known for its opaque lending practices. And as a result, China’s reluctance to join in and grant debt relief as part of the larger initiatives, like the Common Framework, has put much needed debt restructuring for many vulnerable emerging markets into limbo.

We’re also seeing some trends within China to prioritize resource security and also deal with the fact that domestic growth is slowing, as I just mentioned. China has started to recalibrate its Belt and Road Initiative or, or the BRI. And in fact, late last year we heard about the shift in projects in BRI to “small is beautiful” in terms of project size. And they’re also trying to look at better sustainability, both in terms of the debt incurred by these projects but also from an environmental perspective.

So now we might see an interesting shift in terms of where China chooses to deploy it investment resources. I think China’s now planning to invest more in commodities and green energy-related inputs in Latin America rather than the traditional model we had been seeing a few years ago where they were plowing money into large-scale transportation infrastructure in places like Africa.

CREBO-REDIKER: So that—there’s so many questions I have for you on the on the back of that very, very good overview that I hope we can come back to. But I do want to turn to Nehad, and particularly as you—as, Tara, you launched us into the conversation about emerging markets. It’s hard to actually lump emerging markets together, so I’m putting this in front of Nehad and saying: You know, as an asset class, there is a huge amount of differentiation. And, you know, we’ll see divergence continue into 2024.

But, you know, a lot of the larger EMs got ahead of the tightening cycle and actually were—you know, they managed to weather some of the worst-case expectations last year. Are we going to see that continue? What are the—you know, we have countries that have managed to pull that off so far. We have other countries that have very high debt distress. And then others that are in the—have defaulted in are in the middle of, as Tara mentioned, some prolonged debt restructurings. So over to you and look forward to hearing how you—how you manage to capture a very divergent group of countries.

CHOWDHURY: Thank you, Heidi, Greg, and Tara. And I’ll just begin with the disclaimer that the views I express are my personal views. They don’t necessarily reflect the Citi research or institutional management view of Citi.

So I’ll start by first just acknowledging Tara’s point about the China slowdown, which has been secular and amplified more recently. Notwithstanding that slowdown, China’s relevance to the global economy has actually been increasing. And if you look at the share of global exports that China accounts for, that number has actually steadily increased since, under the Trump administration, we start to see the start of the trade war. So what used to be something less than 13 percent share of global exports, it’s now around 15 percent or more. So it’s actually increased, despite that. The other fact is the use of Chinese currency in global trade transactions. That has also steadily increased, notwithstanding the use of sanctions or other things that might have otherwise deterred the interest in Chinese assets or access to Chinese markets.

Let me pivot now for a moment on some of the macro themes that are informing our view of both emerging markets and advanced economies for this year. And I can’t overstate the point that Greg made earlier, is that this is going to be another year of subpar overall macro performance. And when you look at long-term trends, and you compare, whether it’s advanced economy or emerging market growth and inflation, on both accounts we are looking at the next five years that are likely to be much weaker than they were pre-pandemic. And that has very important implications for, you know, all of the macro variables in all of these economies. But the one, Heidi, that you mentioned, which is, I think, of particular concern—not necessarily in the immediate horizon, but over the medium term—is the implication for fiscal policy and public finances.

And, you know, we’ve been through in the last, I’d say, fourteen years two distinct phases. One was the post global financial crisis phase. And the other one was the post pandemic phase. And in each of these phases, we saw a very rapid buildup in debt stock, but also a deterioration in debt affordability. And there are various ways you can measure that, but through one very common metric what we observed is that for emerging markets through both periods, post-global financial crisis and post-pandemic, the cost of service as a share of revenues, that has actually risen at a very rapid rate.

Advanced economies, post-GFC, despite much higher debt stocks they benefited from QE and very, very low rates. But what is interesting is that through the last one and a half years of now the exit from QE and rate rises, we’ve almost reversed the benefit that advanced economies have had from those lower rates. And now, when you look forward for the next five years, it is both the stock and the affordability of that debt that is diminishing. So we’re coming into 2024 with actually, from at least a fiscal standpoint, a diminished policy space. And so in the context of a year where uncertainty could rise and you need policymakers to be able to dig into whether it’s monetary or fiscal policy space, at least on one of them that has diminished. And I’d say I agree with Greg that the market perception or pricing about how aggressively the Fed can cut, that is still, I think, an open question.

So one more point I’ll make before I hand it back to you is with respect to debt. One thing that we saw in 2022 and 2023, partly, was an unprecedented number of defaults among frontier and emerging market issuers. And that started to taper off in 2023. And I think the outlook now in terms of a more dovish Fed, that will, at least initially, facilitate strong capital flows to emerging markets. And we’ve seen this year so far the issuance has been very robust. And we expect that that will persist. But it is highly conditional on both that outlook for monetary policy but also on hoping that the uncertainty and the scope of surprises from elections don’t surprise too negatively.

And one more just reminder on those—the politics and geopolitics is that we’ve also been through an unprecedented multiyear period of domestic social upheaval in most countries. Social contracts in many of these places are getting renegotiated around issues of housing affordability, K-shaped recoveries and inequality, food insecurity, and just national security and national security issues also. And all of that we have been—I’d say, you know, humbly—we have not been collectively good at anticipating or forecasting those turning points. And I think this year will be no different in that regard.

And policy uncertainty is susceptible to very abrupt spikes and is likely to remain very elevated. With the elephant in the room being the U.S. elections, which—you know, we worry about country risk in EMs, but oftentimes the source of that risk stems from outcomes in the U.S. and policy choices, including foreign policy choices, in the U.S. And in this regard, I’ll—just one last comment on mention is that sanctions have become a new tool and more relevant tool of foreign policy. And they have very nonlinear impacts on other emerging markets. So I’ll pause there and hand it back to you.

CREBO-REDIKER: So I mean, I think, you know, going back to your—going to your final point on the consequence of the U.S. election, there’s a global implication for markets for the use of economic tools, whether they’re sanctions or export controls or, you know, trade and tariffs as mechanisms that can really surprise. And it’s very hard to manage, and quantify geopolitical risk, which is why I think a lot of—a lot of companies, and institutions, and investors are often blindsided when events happen.

I’d like to go back to Tara. I know another part of the world that you spend a lot of time on is Japan. And I’d love to hear your thoughts. Japan was an outperformer in 2023 and could be set to be one in ’24, as well. But talk us through what your views are on Japan, Japanese markets, and the Bank of Japan.

HARIHARAN: Of course. Japan is a fascinating case, as the last big central bank left in easy monetary policy mode. Arguably, it’s high time that the Bank of Japan started hiking rates. If you look at inflation, it is printing above 2 percent. And I would argue that the yen is right now so weak that it is increasing imported inflation for consumers. And consumers are all already pretty disgruntled because real wages continue to be negative. The BOJ may also want to consider that they hike sometime soon before the Fed starts its rate-cutting cycle, so as to avoid significant yen appreciation versus the dollar which would actually be further deflationary.

But as things look right now, a January move by the BOJ looks very unlikely because they had a recent earthquake, of course, which poses some risks to growth. There’s also a rumor that the Bank of Japan is thinking of revising both its growth and inflation outlooks downwards as early as the January meeting on the twenty-third. And, most importantly, Ueda-san and his colleagues are looking for higher wages in Japan, especially from the smaller firms who have been more hit—more buffeted by high inflation and by other headwinds and are finding it a little bit more difficult to raise wages.

Separately, we also have to consider the effect of politics. Scandals within the ruling LDP political party may mean that the BOJ avoids hiking anytime soon so that they don’t rock the boat at a time of political volatility. So they may have enough economic data, wage data, inflation numbers by April to start moving, or at least to give some strong signals. But my belief is that rate hikes will be extremely gradual in Japan, given that Japan’s high debt load will continue to restrain monetary policy. And this is what, of course, is called, classically, fiscal dominance.

The other risk is, of course, also that even if Japan starts hiking rates, they might keep yield curve control in place so as to stabilize yields towards the benchmark ten-year side of the (tenders ?), even while they start their rate hiking cycle. So if you ask me about how I would position for this, I do think that there will be a move in terms of a rate hike this year from Japan. And that’s why we are personally short ten-year Japanese government bonds, assuming that the yield is going to go higher.

However, interestingly, we are also short the Japanese yen, because, as I mentioned, any pace of rate hikes is probably going to be pretty glacial. And all said and done, the rate differentials between the U.S. and Japan will remain wide, and so the yen should continue to stay weak. And if the yen stays weak, of course, that should continue to support Japanese equities, though I will not assume too strong of you on that side. I’m much more convinced on the rates and the currency side of the ledger.

CREBO-REDIKER: Thank you very, very much. I think, between the three of you, we have a lot of fodder for conversation. But before we turn it over to audience questions, I want to turn back to Greg and ask a little bit about his views on Europe. We had—you know, Christine Lagarde came out yesterday again saying that rates are going to decline as soon as we have certainty that we get to that 2 percent estimate by 2025. But Europe is a big story of differentiation as well, in particular Germany. So I’d love to hear from you on what both your monetary and fiscal outlook is for Europe, and what countries are you paying particular attention to in ’24?

DACO: Yeah, I think that’s a great way to frame the question, because what we’re seeing right now in the eurozone is that there’s really a lack of a clear growth engine. The eurozone has really been stagnant over the course of the past year, but it’s been highly desynchronized. And I think that’s one of the interesting facets of what we’re seeing in terms of economic activity across Europe and across the eurozone is that the former growth engines are now the laggards and the former economies that were under a lot of stress—if you recall the debt crisis back in 2013-2014—are now actually the leaders in terms of economic momentum.

Part of that is cyclical. Part of that, I think, is to some extent structural. We’re likely to continue to see an environment where Germany remains quite restrained in terms of economic activity. We had German consumers contracting in 2023, in terms of consumer spending activity. We have the industrial sector that is under a lot of pressure, continues to be a lot under a lot of pressure. In Germany construction activity is also under a lot of pressure. And the prospects for growth in 2024 are actually quite muted. We have the German economy actually flatlining in 2024 after a year of contraction in 2023. So this recessionary environment is a key concern in the heart of Europe.

Meanwhile, Spain, Italy, France are actually likely to fare a little bit better. Spain in particular, I think, is a very interesting story where we saw growth around 2 ½ percent in 2023 driven by the service side of the economy, which continues to have that positive momentum. We’re likely to see a little bit less growth, but still in the 1 ½ percent vicinity. I think the interesting dynamics that we’ll have to pay close attention to when it comes to Europe is how strong income momentum is as we navigate through the year. We do anticipate to see a little bit of a firmer trajectory for income that outpaces inflation. And that means that people’s real wages, real salary—so salary adjusted for inflation—are actually stimulating consumer spending activity.

I think in terms of the fiscal framework, we’re going to be in an environment where fiscal consolidation, which is a theme I mentioned for the U.S., is going to be actually more visible. We’re going to be in an environment where a lot of the measures post-COVID are expiring, where we’re going to see a fiscal drag on economic activity, much more attention to some of the key thresholds in terms of deficits and debt that will constrain economic activity. We saw it a couple of months ago in Germany, with a restraint in terms of the German government’s ability to spend off budget.

And we’re going to be in an environment where—and this is the third element—where inflation is going to continue to moderate, perhaps faster than expectations. I would anticipate that in this environment where growth is fairly soft we continue to see this downward trajectory in terms of inflation, allowing the ECB to perhaps actually lead the way in terms of easing monetary policy. Yes, Lagarde is very much keen on avoiding early loosening of monetary policy or premature loosening of monetary policy, but I think the case is quite strong in a weak growth, low inflation environment to actually lead the way in terms of monetary policy easing. We anticipate 125 basis points of rate cuts by the ECB over the course of 2024.

CREBO-REDIKER: Well, just before we open it up for questions I do want to touch on another important economy. And that is India. And I am going to—I’m going to hand that over to Tara to start, but I’m happy to have Greg and Nehad jump in as well. because I think that is—it’s a very—they’ve had incredibly strong growth, and are certainly, you know, an economy to watch in 2024. But, Tara, walk us through how you’re looking, as an investor, at India this year.

HARIHARAN: Of course. India, of course, has been posting very strong growth numbers, led by both government spending as well as robust consumption. And it has been enjoying solid investment inflows. Right now also from a fiscal perspective, the BJP government does look pretty comfortable heading into the April-May elections. So it hasn’t needed to do quite as much in terms of the usual pre-election populist fiscal expansion. So that’s also a benefit.

On the other hand, I would point out some structural and medium-term caveats for India. Right now, India does face trade risks from this ongoing Red Sea crisis, which we haven’t really touched upon. I’m hoping maybe some audience questions will ask about it. And of course, India continues to be very dependent on energy imports. And it’s always vulnerable to high food prices. We know that food inflation is a big political bullet point here that that every election comes up.

In terms of the boost from friend-shoring and nearshoring, again, these are all positives for India. And we’re, of course, seeing a lot of the shift of companies like Foxconn and Apple to produce more in—at least, assemble more in India. But I would want that that this trend will take a little longer to durably support investment and growth in the country because private investment also needs to pick up the baton from strong public spending in India. And we also have high rates of unemployment and a relatively under-skilled labor force, even though, of course, it’s a huge labor force.

So as much as people talk about the large, positive demographic dividend India has of right now being the world’s most populous nation, and a pretty young population, let’s not also forget that a large demographic dividend can also be a liability.

CREBO-REDIKER: So I’m going to hand it over to Alexis to walk through any of the questions we might have from the audience, but I hope that we do touch on a number of the geopolitical conflicts that we should all have our eyes on, as well as commodity markets and the impact that we that we know both food insecurity and commodity—high commodity prices and energy prices have on all of—all of what we’re talking about today. So, Alexis, do we have questions from the audience?

OPERATOR: Yes.

(Gives queuing instructions.)

CREBO-REDIKER: I think I would also—sorry—I would also encourage—because I didn’t—I started with this, but I forgot to open it up, any of the panelists feel free to question one another as well?

CHOWDHURY: Thank you. While we get the questions maybe I’ll just kind of opine on two of the topics that came up.

So on India, of course, India’s having elections. And I think the consensus view is that Prime Minister Modi will be returned with a clear majority once again. And I think there’s no reason to doubt that. And one of the things that has—India has benefited from in recent years is that policy continuity. And if the policy continuity persists, and a key element of the policy continuity is the generally business-friendly leaning of the BJP government, that suggests that the other structural drivers of strong growth will be supported by the strong sentiment that will accompany that policy continuity and clarity of what the goals are. That’s one on India.

On Europe, Europe is very interesting. And I agree, of course, with the view of growth is uncertain. There’s also a lot of intra-Europe divergence in growth, much more than we’ve seen in a long time. But the other thing that’s very interesting about Europe, despite—we talk in general terms about debt levels being higher—is the other interesting fact about the euro area periphery is that we have actually seen very significant fiscal consolidation and deleveraging taking place in the periphery. And so in a world where we’re concerned in the medium term about deteriorating, you know, potentially, creditworthiness, the periphery of the euro area has demonstrated not just resilience but actually quite notable improvement in how to manage their fiscal vulnerabilities and their fiscal trajectory.

OPERATOR: We will take our first question as a written question from Manoj Gopalakrishnan, who asks: For Gregory, if price levels are still elevated, diminishing pricing power for consumers, could you expand on your view that inflation is coming down and is a tailwind?

DACO: Yeah. I think that alludes to one of the common confusions. Whereas, you know, economists and policymakers and academics talk about inflation, the average person, the average consumer, the average business leader, focuses on price levels on cost levels. And that goes back to the point I was making earlier about cost fatigue. We are in an environment where the cost of most everything is significantly higher than it was pre-pandemic. Now, granted, we saw some positive progress in terms of real wages in many economies around the world, thanks to inflation coming down. But people, when they perceive that—and this goes back to one of the questions that Heidi mentioned—the perception is not the same as what is actually materializing.

So there is that dichotomy between an environment where people feel like the cost of most things is much higher and constraining their ability to spend and invest, and an environment where inflation has been diminishing. In just focusing on the U.S., for example, we had inflation on a CPI basis peaking at 9 percent in June a couple of years ago. It has now fallen to around 3 percent. And that has been a significant improvement in the trajectory. And, as I mentioned, I do expect the disinflationary combo from easing final demand, supply that is coming back online, a better balance in the labor market, to continue driving that disinflation momentum going forward.

OPERATOR: We will take our next question as a written question from Willem Buiter, who asks: The fiscal situation of the U.S. and most other advanced economies is clearly unsustainable. Fiscal tightening is required. Do you think this could happen in 2024? And does this pose a material risk to economic activity?

DACO: I can take the lead or, Nehad, if you want to take this one?

CHOWDHURY: No, please go ahead, Greg. No, no, please go ahead.

DACO: OK. (Laughs.) But, yes. I mean, there is an undoubted need to address the fiscal situation in the U.S. We’re on a trajectory where fiscal deficits on a year-to-year basis are likely to average between $1 ½ to $2 trillion over the next decade. We’re also in an environment where there is increased focus on the cost of that debt. That cost is visible in the interest cost on an annual basis, which is rapidly increasing and reducing that fiscal space.

So, Nehad, you mentioned that for EMs we were increasingly focused on fiscal space. But I think even in the case of the U.S., we have to consider the possibility that this increased—this ongoing increase in deficits and in the debt relative to GDP is putting upward pressure on the cost of that debt, leading to a premium on ten-year yields, for instance, for government bond yields. Which, in turn, is eroding private sector investment. Now, you may not see it in a flexural environment, where you see monetary policy still being the key driver of interest rates, but as you focus over the next five, ten, twenty years, that is going to be an important part of the narrative.

I don’t think much will be happening in 2024. It’s an election year. There is talk right now around the child tax credit and other exemptions for tax—corporate tax subsidies. I don’t think that has much legs. The key focus right now is just addressing, again, the risk of a government shutdown in the next few days. The debt ceiling issue will be something to deal with after the election. So a lot of uncertainty with regards to 2024. But I don’t think much will be happening this year.

HARIHARAN: If I may just add a little bit to that. Sorry, Nehad, please go ahead. And then I’ll jump in.

CHOWDHURY: I was just going to say that in the near term the transmission channeled from that higher debt load is likely to be very muted, but unless there’s obviously a very violent market reaction and a repricing in the long end of the curve. And we don’t—probably don’t anticipate that for 2024, but that’s certainly a risk that is more elevated now than it hasn’t been for a while, especially given that the quantum—the nominal amount of financing that’s needed, that needs to be digestible by the market. And that’s going to be an ongoing experiment.

HARIHARAN: And if I can just pile on, on the same subject. I do think fiscal risks this year are going to keep ten-year treasury yields elevated. Again, because we go back to the issue that we may—we may have a partial shutdown as early as January nineteenth. And while in the past, of course, markets have brushed off shutdowns pretty quickly, I think this time may be different given that last year we even got a ratings downgrade on the grounds of political brinkmanship just becoming too excessive in the U.S. So you got to remember, now the U.S. has a AAA rating from just one of the large agencies.

And while we may—we may still be the ultimate destination of last resort and the ultimate safe haven, I don’t think we want to lose that rating. So even if yields fall in the front end because of the Fed starting rate cut cycle, I do think there are many upside risks to ten-year yields. I had already mentioned the increasing supply, the treasury issuance. We’ve got a big—a very big budget deficit. And to a certain extent, we’ve also got slowing foreign demand for U.S. Treasurys, which is another geopolitical angle completely. So a lot of risks ahead.

OPERATOR: We seem to have lost Heidi, but please feel free to continue submitting your questions and we will run through them. We have two questions from Joshita Varshney and Ash Hambardzumyan, both revolving around the Israel-Hamas and Russia-Ukraine wars. How do you see these impacting the global economy in 2024? And, moreover, with Europe diversifying their energy imports significantly, can we say that the global impact from the conflict is diminishing, barring severe escalation involving NATO?

HARIHARAN: So if I may just jump in on the Israel-Hamas situation, and the oil and supply chain situation, I would then leave it to both of you, Greg and Nehad, to talk about Russia-Ukraine. So, of course, we’ve got high action now in and around the Red Sea. We have the strikes last night where the U.S. and U.K.—directly on the Yemeni Houthis. But even with this, you can argue that the geopolitical risk premium priced into oil is pretty small. I still expect oil will remain range bound in the current range we’ve been trading in with the—basically in a $70 to $90 a barrel range for the foreseeable future.

These tensions in the Middle East, thanks to the Israel-Hamas situation spilling over, of course, into the Houthis and the Red Sea, have not yet added this high premium just because supply hasn’t really been disrupted yet in oil. I think the bigger shock risk would be if Iran gets more directly involved, which is definitely a risk. And if they do close the Strait of Hormuz, through which 20 percent of world oil demand transits, then we may have a serious problem and serious upside in oil prices. Or, separately, if the Houthis did what they did a few years ago and directly try to attack Saudi oil infrastructure and try to reduce supply further.

But I think demand picture is basically keeping oil relatively tame. Global oil demand is probably going to grow less this year than last year because various economies are slowing, as we have discussed, and also a strong non-OPEC supply, particularly from the U.S., has kept prices tame, even though the OPEC countries and Russia have been trying to reduce their supply and trying to basically balance or strengthen the market. We also have to remember long-term we should not rule out decarbonization and electric vehicle uptake. I do believe and hope that this will work. And in that case, oil could fall well below $50 a barrel in a few decades from now. Also, oil supply from places like the U.S., Guyana—which is which is an important flashpoint—and Brazil may continue to increase. And for these reasons, the oil market could remain pretty tame.

CHOWDHURY: I’ll just add that with respect to both conflicts, the one over Ukraine and the one centered around Israel and Hamas, none of these—neither of these are in a steady state yet. And so we’re still yet to see kind of the new equilibrium emerge from them. And as a result of that, there’s still room for accidents and things to get much worse before they get better. But we don’t usually, in the markets—I haven’t seen markets respond to that until you find yourself actually in that observed new worse environment. And markets, I think, have been somewhat slow to price in those adverse scenarios.

With respect to the impact on oil—and, Tara, maybe you can talk more about this if I’m not saying this perfectly accurately—but I think we’ve come into a world where there’s a long-term trend whereby the demand-supply balance in oil markets are favoring a gradual decline in oil prices. Partly because of the oil intensity and the demand in the production of GDP, partly because of the initiatives related to climate change. But for a variety of reasons, that long-term trend I think is in place. And we also have a lot of enormous spare capacity by a lot of the large oil producers.

So you’d have to see oil supply come off the markets in a very large and sustained manner to have a sustained disruption and sustained spike in oil prices, which is why the conflict in the Middle East, it really needs to move into a much more adverse and much more intense phase that is accompanied by persistent supply disruptions to see that geopolitical risk premium not just materialize but actually become something that truly reflects fundamental supply-demand imbalances in oil markets.

DACO: Can I—can I add one element with regards to that? Because I very much agree with the picture that you both shared. But I want to stress one element that is perhaps a little bit different in terms of the global picture. It’s that we are still in what I call a supply-fragile world. And we’re likely to remain in that type of environment post-COVID for the foreseeable future. And what I mean by that, is that in the past the key issue—prior to the pandemic—was insufficient demand across some of the major economies. We’re still in an environment, and you alluded to that, where we’re rebalancing. Where we’re still trying to find that equilibrium between supply and demand.

And so whereas in the past we could potentially discount some of these geopolitical events, natural disasters in other places around the world, I think increasingly businesses are realizing that shocks that affect regions where they may not have any activities could eventually affect their business. And I think that the situation in the Middle East is quite interesting in that regard, because, as you both alluded to, oil prices are the number-one channel through which you could see global effects. And we created different scenarios looking at a contained versus a more fluid situation, or uncontained scenario. And really, the key driver is oil prices.

If oil prices stay where they are—and, actually, they have declined since the onset of the war—that is actually not a negative factor for the global economy. But if you start to see financial market volatility, if you start to see global trade disruptions with ships having to go around Africa instead of the Red Sea, or having to take out insurance, that potentially feeds more supply disruptions in the supply-fragile environment and can have effects on inflation as well with economies most dependent—Europe, in this case—most exposed to this potential risk.

HARIHARAN: And on Russia-Ukraine—

CREBO-REDIKER: Sorry, I apologize, I—

HARIHARAN: Oh, sorry, Heidi. Sorry that we lost you in the middle. So we were—we were discussing Israel-Hamas and then we were also going to Russia-Ukraine. And if I may just venture a few starting points, and then let Greg and Nehad pick up from there.

I think it’s unfortunate that the Russia-Ukraine war has kind of faded into markets memory, because the market does have rather short memories. But mainly because Russian oil supply even with the sanctions—and, of course, that was the intention of the sanctions, not to—not to reduce oil supply, just to bring down the price. We continue to see Russian oil flow. And right now at least, the Ukraine grain deal appears to be holding up. So the effects on oil and food inflation have become more limited.

I think the most fascinating aspect of the next stage of this war—I’m not going to prognosticate on when it ends or how it ends—but is the latest development, of course, of the Western allies trying to figure out what to do with frozen Russian assets and how to use them as reparations for Ukraine. I think it—I think it is a pretty bold and controversial idea to just seize those assets forthright and basically deploy them. I think there’s also, of course, the more indirect method that the EU is suggesting, which is to do a windfall tax on the profits on these assets.

But this is going to be a very fascinating—set of fascinating precedent, because you can argue that many geographies in the world which face U.S. sanctions would be rather, you know, terrified that the U.S. might be getting a little bit over its skis in terms of what it’s able to accomplish. And in the long term, there is a risk, I think, that that even less investment is made into dollars, just because of the risk that it gets seized in a future conflict.

CREBO-REDIKER: So, Nehad or Greg, do you want to chime into to Tara’s latest comment, particularly on the central bank reserves?

CHOWDHURY: I mean, on the central bank reserves I think we also touched on the bid on U.S. Treasurys from central bank holdings of dollar assets. And so there is now this perceived insecurity around the accessibility of those dollar assets because of the ability to confiscate those assets at a time of geopolitical stress or disagreement that might start to have an effect on the margins, I’d say, the perception of the—or, the desirability of dollar assets. But I don’t think we’ve seen that yet, despite that, the potential for that. This is one of those things that we need to watch very closely because, again, the use of—alongside the use of sanctions, these have very nonlinear effects. So it’s not that we’d see a very necessarily discernible trend towards that. We may just wake up to it in surprise one day.

CREBO-REDIKER: Well, I know Alexis says we have several more questions out in the audience. So why don’t I hand it back to her. And, again, apologies. I lost my wi-fi altogether. So Alexis, please.

OPERATOR: We will take our next question from Paul Maidment, who asks: The rightward populist movement in most G-7 economies is likely to be confirmed in this year’s elections. What are the implications for trade and investment protectionism, especially if Trump returns to the U.S. presidency?

HARIHARAN: I’m happy to take an initial stab at that, as someone who’s watching China very closely. And we know that at least from his platform rhetoric so far, President Trump has really directed most of his trade energy is towards China. So we have heard about the possible risk of a 10 percent increase in tariffs across the board, what President Trump called the ring around the collar. And then we also have the even more significant possibility that China loses its permanent normal trade relation status, or the equivalent of its most favored nation status, which just basically means that tariffs are going to go up on Chinese goods.

Now, this is completely at odds, I think, with the much more surgical and tactical methods that the USTR, the trade representative, under the Biden administration is trying to do, where we are thinking of recalibrating tariffs to maybe increase them on some sensitive sectors related to, again, national security and to green energy, and those industries, but at the same time bringing down tariffs on consumer goods. So that move may be, of course, completely halted if President Trump comes back in.

And if tariffs go up, as we have at least seen so far from economic analyses, the primary burden will still be on the U.S. consumer. Now the U.S. consumer may still be resilient enough to take another bit of tariff hikes on Chinese goods, but the point is that the pain may not necessarily be taken on the Chinese side. Especially if China is deflationary and exports deflation to the rest of the world. So they may even be able to offset some of the tariff hikes by basically having even lower prices. And I just want to—I want to put in here, I’m sure all of you have heard of that app Temu—T-E-M-U—which sells extremely inexpensive products on the—on the internet. And so if more Chinese companies do that and flood us with goods, then tariffs won’t make a difference.

But a broader question about, you know, the effects of this protectionism. The other argument made about Trump’s foreign policy is that it’s isolationist and it looks inwards. And in that sense, some people are saying that while tariffs may go up, and so that’s a bit of an economic threat to China, in other ways this may actually give China a little bit more leeway in in terms of global influence, simply because the U.S. may not be quite as willing to engage on international scale in various other locations, including emerging markets. And in that case, China may—in the in the sense of playing the long game—may actually appreciate a Trump administration. Again, I don’t want to get political here, but it’s something to think about.

DACO: Can I add—

CREBO-REDIKER: I was going to say, Greg, the—you know, one area, particularly on the isolationist trajectory, is the—probably the pullback of actually working with allies, and particularly in Europe. So thinking about the Russia-Ukraine conflict and what the spillover effects would be in in Europe, I’d love to hear your thoughts.

DACO: Yeah. Just perhaps taking a little bit of a step back from the actual elections, because I think one of the key developments over the last few years in D.C. has been the fact that there’s actually bipartisan agreement in supporting more of a U.S.-based industrial policy. And the idea there is essentially to protect domestic industries, to heighten competition when it comes to strategic industries, and to build resilience in the face of potential disruptions in supply of whatever it may be post-pandemic. And I think that’s important to think about because, initially, you know, having the Democrats come into the White House, you might have said that traditionally that would have been more protectionist, and having Republicans come into the White House would actually be more favoring a free trade.

But we’ve seen a certain form of consistency when it comes to trade protectionism and when it comes to subsidies that are aimed at supporting domestic industries. The IRA is a prime example of that. But the CHIPS Act is also another example of that, supporting domestic industries via greater incentives. I think it’s important to remember that there’s going to be this greater focus as we navigate through the next few years on not just controlling what comes into the U.S., but also controlling what goes out of the U.S. And some of the recent measures that were passed by CFIUS are aimed, essentially, at controlling exports of capital, export of talent, and export of embedded technology.

That has much less of a visible impact to the average person. Tara, you were, rightly so, mentioning the potential inflationary impact of tariffs. When you’re limiting technological exports, you’re essentially targeting a few industries. But for the average consumer, nobody sees it. And it’s a win-win from the administration’s perspective, regardless of who is in the White House. And I think that’s very important to keep in mind.

CREBO-REDIKER: Nehad, do you want to chime in or should we go to the next question?

CHOWDHURY: Only to just emphasize that the impacts of these tend to be very micro level, industry specific. They can aggregate and manifest at a macro level, but in terms of if you look at the relationship between the tariffs and what they’ve had in terms of China’s importance in global trade, we already discussed those numbers. And those actually haven’t diminished China’s share of global exports.

CREBO-REDIKER: So, Alexis, can we go to the next question, please?

OPERATOR: We will take our next question as a written question. You spoke about ongoing global conflicts and potential effects on oil and energy, but how does the crisis in the Red Sea and implications for global freight and shipping costs play into your outlook on inflation for 2024?

CREBO-REDIKER: I will leave that open to anyone who wants to take a stab at it.

HARIHARAN: I’ll start with a with a very generic set of responses, and maybe Greg can quantify them more with his expertise.

I too am a little bit concerned about the possibility that that goods inflation, which we had finally started to see come down after the pandemic disruptions, may start to come back again sometime around the middle of the year, assuming a few months’ lag from these shipping delays and increasing costs that we are seeing. Because a lot of container ships are basically bypassing the Red Sea and now going all the way around Africa, basically, to get around the around the world. So there is a significant risk that one of the important deflationary, or at least disinflationary, factors in global inflation, namely core goods, start to, if not go back up again at least become more sticky and stabilize where they are. And that’s something I do think that central banks should keep an eye on.

I know that’s supply-side inflation and, in theory, that’s not something that central banks directly target. But, I mean, given, for instance, in Europe, a lot of the inflation that they saw was primarily supply-side related, I think we cannot rule that out in in factoring in Central Bank decisions. So I think we need to watch the passthroughs. Of course, as economists, all three of us, I think, can vouch for the fact it’s become very difficult to figure out how quickly or how slowly prices pass through from the wholesale side and the—you know, the shipping side, into the producer and consumer side. But I do think this is a significant risk, maybe for the middle of the year. Maybe it comes after many of the major central banks have already begun their cutting cycle. But we definitely have to watch it.

CREBO-REDIKER: Greg.

DACO: Yeah. I think that’s a great way to frame it. You know, goods prices were deflationary before the pandemic. They were falling about two to three tenths on an average per year. We’re now back to zero, essentially. So when you look at global goods prices, they’re essentially trending around zero, which is great, coming back from very high levels of inflation. But still a little bit higher than it was pre-pandemic. And that adds up, year after year after year.

As to the effect of the disruptions that we’re seeing today, they need to last for a bit of time before they actually become visible in terms of broad inflation metrics. And it’s not just, you know, the route. It’s the potential cost of that route in terms of fuel prices. And we’ve seen some upward pressure there. And it’s also—and this is going to be, I think, a key topic going forward—the insurance cost of navigating through oceans that are increasingly under a number—of stress.

And I think the insurance cost is a factor that we don’t usually talk about when we talk about inflation, but increasingly across most sectors—whether it’s health care, the automotive sector, homeowner, rental and real estate, or, in this case, trade—insurance costs I think are going to be something that we have to monitor very closely in an environment where supply continues to be under pressure, geopolitical risks are elevated, and climate is changing. That, I think, is something—it’s another topic, but I think it’s something to monitor closely.

CREBO-REDIKER: Well, we have—we have one minute left to go. I would just want to do a closing round with what are you most optimistic about in 2024? Nehad, start with you.

CHOWDHURY: I think I’m optimistic about the persistent resilience of both advanced and emerging markets to contend with these uncertainties and shocks. I see no reason why that would change, notwithstanding the diminished policy space to respond on one side.

CREBO-REDIKER: Greg.

DACO: Productivity growth. I think that’s one area where we have a missing part of the puzzle that addresses both the supply constraints and inflation constraints. We’ve seen strong productivity growth in the U.S., in part process based, in part tech driven. I’m optimistic about that.

CREBO-REDIKER: And, Tara, take us home with what you’re optimistic about.

HARIHARAN: So mine is a bit derivative of both Greg and Nehad’s. But I’m pretty positive about the continuation of American growth exceptionalism, especially because the U.S. retains its edge in innovation and AI. And also, as we’ve been discussing, government initiatives like the Inflation Reduction Act and the CHIPS Act, they’re already boosting U.S. construction spending. And they’re starting to bring back, you know, some important advanced manufacturing to the United States. We do have some issues related to labor costs, and we probably do have to pick up productivity further, but I’m pretty sanguine on the outlook for the U.S. in the medium term.

CREBO-REDIKER: I would—I would agree with you on that point. And then thank all three of you for joining us today. That was a great discussion. I’m sorry I missed part of it. I thank everybody who joined online. And we hope to come back later this year with, you know, a reckoning of where we are on our—on our prognosis for ’24 and the economy.

Thank you so much for joining us today. Have a good week.

CHOWDHURY: Thanks.

HARIHARAN: Thank you, everyone.

(END)

Top Stories on CFR

Russia

The new defense treaty demonstrates a growing closeness between the two pariah states that is likely to make the rest of the world uneasy.

LGBTQ+

Election 2024

Each Friday, I look at what the presidential contenders are saying about foreign policy. This Week: The United States may come to rue its failure to get its fiscal house in order.