The Still-Challenging Path Back to “Normal”

Our latest forecast for the global economy, offered by Chief Economist Nathan Sheets and team, seeks to balance three ongoing themes. First, we continue to see evidence of resilient service-sector performance, with global labor markets generally staying tight. Second, given these developments, inflation continues to run above official targets, with central banks finding it challenging to end their inflation-fighting policies. Third, significant geopolitical pressures persist.

Given these factors, we’ve left our global forecast little changed from last month. We continue to see global growth slowing to 2.3% this year from 2.7% last year. Our assessment is that monetary policy, which is still restrictive in many economies, will restrain activity and help loosen the labor market. But we’re also keenly aware that the global economy has shown surprising resilience. Any labor-market slowing to date has been incremental at most and our 2024 growth forecast has been on an upward trajectory in recent months; given this, we see the risks to our forecast as still skewed toward stronger performance.

Strength in Services Continues

The global purchasing managers' indices (PMIs) for services and manufacturing strike us as particularly useful measures of performance. The global services PMI retreated through much of last year, but hit bottom in October and has moved steadily upward since then, with its current reading of 54.1 a signal of considerable strength in the services sector. Even so, we continue to expect some tapping out of services demand in the months ahead.

Meanwhile, labor markets have remained tight, with unemployment rates across a broad set of countries still generally at or below pre-pandemic levels. The U.S. has seen its jobless rate edge up in recent months to 4%, but labor-market data haven’t delivered a clear verdict about what’s driving this rise.

Wage growth has also remained rapid in many economies, far surpassing the pre-pandemic pace and keeping central banks on high alert. A particular concern is that services inflation continues to run hot in many countries, frustrating central banks’ efforts to reach their targets. And the global manufacturing PMI has edged up to readings slightly above 50, which points to a tepid recovery. A broader rotation of spending toward goods is an important part of our forecast, and that should help take the heat out of labor markets and so temper services inflation.

Taken together, many of the global macro issues we’ve wrestled with over the past two years remain unresolved. As such, we see the global outlook as very much a work in progress. The question is whether these developments — particularly, the strength of services spending, tight labor markets, and outsized services inflation — ultimately unwind as we expect. If not, it’s increasingly possible that we’re seeing the onset of a more sustained “new normal” for spending and activity.

Central Banks Face a Complicated Exit

In recent months, several major central banks have been bedeviled by the challenge of finding a path to the exit, with the Fed front and center. First-quarter U.S. inflation data proved much stronger than anticipated, which threw cold water on market expectations and caused the Fed to backpedal on its plans to ease. Markets have gone from pricing in as many as six rate cuts for the year to expecting just one to two, which has been a central factor shaping the performance of global markets. Our current projections call for the Fed to remain on hold until September, a meeting later than our previous forecast.

Chair Powell has highlighted that a weakening of the labor market — and of the economy more generally — could also lead to Fed rate cuts, and some indicators have pointed to softer U.S. performance. But with other data remaining somewhat stronger, the next several quarters will be critical in determining whether the U.S. economy achieves a soft landing.

The European Central Bank (ECB), in contrast, cut its deposit rate by 25 basis points at its June meeting, but the move was accompanied by relatively hawkish communications, with the Governing Council clearly concerned about the tone of recent wage data. We now see just two further ECB rate cuts this year, in September and December. Elsewhere in Europe, we now think the Bank of England will likely remain on hold until September. The upshot is that we see all three of these major central banks proceeding with rate cuts in September, and expect their cutting cycles will continue through 2024.

The Bank of Japan has remained on the sidelines. The good news is that its 2% inflation objective looks to be coming into view, but the pressures associated with the historically weak yen threaten to force the central bank’s hand. That has Japanese officials eagerly anticipating the easing of Fed policy, which should help the yen rebound. Many emerging-markets central banks are already well into their cutting cycles, but the trajectory of cuts has generally been gradual, and in several cases the scope to cut rates has been less than anticipated.

Bottom line, central banks have been locked into restrictive policies for longer than they (and we) expected when 2024 began. As noted above, the looming question is when wage growth and services inflation will return to a pace more consistent with central-bank targets, as well as how confident we should be that cuts will indeed come in September. The answer will depend on the durability of economic activity in key countries.

Geopolitical Pressures Remain in Play

The global economy continues to endure a range of geopolitical challenges. The Russia–Ukraine war grinds on, the painful conflict in the Middle East continues, and several other developments have recently made headlines. These include the Biden administration slapping sizable tariffs on a targeted set of Chinese goods, including 100% tariffs on imports of Chinese electric vehicles, and a series of important election results in major G-20 countries.

While no geopolitical development has proved a game changer for the global economy or markets so far, such pressures are clearly in play and may yet reach a boiling point. We place particular emphasis on the potential risks from France’s snap elections and, of course, uncertainties surrounding the U.S. presidential vote. Such uncertainties are likely to ebb and flow in markets through the end of this year and into the next.