Global Economic Outlook & Strategy: The Final Chapter of Post-Pandemic Adjustment

A new Global Economic Outlook & Strategy report from a team led by Citi Chief Economist Nathan Sheets notes that the global economy continues to motor forward, while acknowledging uncertainties about its near-term prospects. While we expect a “divot” in developed markets’ performance and heightened uncertainty over the next several months, we also expect these strains to be short-lived, with central banks ready to temper the pressures by shifting policy to a more supportive stance. The bottom line is that we’re in the final chapter of post-pandemic adjustment, with the coming months set to reveal how these storylines are resolved.

We now see global growth coming in at 2.5% this year, just slightly softer than last year’s pace and appreciably higher than our projections when 2024 began. Growth next year looks poised to continue at a similar rate. At the same time, we still have worries about global growth’s near-term prospects. While emerging-markets economies should continue to expand at a 3.5% pace in the second half, for developed markets we anticipate markedly softer performances from the U.S., Canada and the UK.

The U.S. outlook strikes us as particularly uncertain. The unemployment rate has risen sufficiently to trigger the Sahm rule, which been a good indicator of past recessions, and housing-market activity remains soft. But consumer spending has shown resilience, and the Citi Surprise Index has climbed back from July lows. The ebb and flow of recent U.S. data has amplified volatility in global markets, which we see continuing.

Global Purchasing Managers Indices (PMIs) offer another important prism. Here, the story continues to be remarkable strength in services and weakness in manufacturing. We’ve seen emerging green shoots for global manufacturing at times over the past year, including strong demand for advanced AI chips, a hardware replacement cycle, and a recent export bounce from some Asian emerging-markets economies.

But none of these developments has fully taken hold, leaving us looking for an explanation for the sustained weakness in global manufacturing and goods demand. We can no longer appeal to the post-pandemic rotation to services, as pent-up demand for services should have played through. One possibility is that high interest rates are weighing on manufacturing, as capital goods and durable goods often require financing. On the consumer side, it’s possible that soft housing markets are inhibiting knock-on spending on appliances, furniture and other housing-related goods and materials. To date, we judge the weakness in manufacturing to be cyclical, rather than indicating a sustained structural shift toward services.

The good news is that inflation looks to be abating, with headline and core inflation both down appreciably from their 2022 peaks and core goods inflation now below pre-pandemic levels. Services inflation remains elevated, but we now see it as on a downtrend as well. Additionally, we project a sharp retreat in oil prices in the year ahead.

The U.S., euro area and China

The U.S. labor market is clearly softening: The unemployment rate has risen, payroll gains have softened, and the ratio of job openings to unemployed workers has declined. What’s also striking, however, is that none of these readings has collapsed or points to any kind of marked weakness. The question in interpreting the labor market’s recent performance, then, is how much weight to put on the slowing trend of the data vs. the overall level of activity. Answering that question, however, depends heavily on answering a different one: Is a soft landing possible?

Our work highlights that six decades of U.S. experience offer no examples of a soft landing emerging from episodes of wage and price disinflation; on the other hand, in previous triggerings of the Sahm rule, the economy has typically already been in recession for several months, making the Sahm rule a lagging indicator of recessions, and that’s not the case this time. Recent readings of U.S. consumer spending have also shown continued growth, with the saving rate falling to 2.9%. This low level suggests consumers are still spending, but may also be getting stretched.

Our bottom line is that the risks for the U.S. economy strike us as finely balanced, with coherent cases possible for an upcoming sharp recessionary slowing as well as for a soft landing. And we note that the post-pandemic period has brought many surprises, with this economic cycle correspondingly unique. One way or another, we expect the next few months will resolve many of these questions.

Looking overseas, we see aggregate growth in the euro area continuing at an annualized pace of near 1%. We expect price pressures to continue to cool, with headline inflation ending the year just slightly above the 2% target set by the European Central Bank (ECB) and so driving significant further easing. The bigger story, as we see it, is the divergence of performance across countries: During the past year, Spain and Greece have grown at a 2% to 3% pace, while Germany’s economy has stagnated and shown particular vulnerability to the gas shock and policy tightening. And unlike in the U.S., euro-area consumers have been hesitant to draw down “excess saving” accumulated during the pandemic.

We’ve lowered our 2024 forecast for Chinese growth to 4.7% from 5.0%. Recent months have seen both manufacturing and services PMIs lose momentum, with consumer confidence stuck at low levels. One headwind is adverse wealth effects from the moribund property sector; a significant share of Chinese households’ wealth is held as real estate, and the sharp retreat seen in recent years has taken a toll. What’s striking is that Chinese authorities have been slow in providing policy support. Why is a puzzle; we note worries about high levels of debt and leverage in the economy, as well as the possibility that authorities may be reserving a significant slug of fiscal stimulus in case the U.S. election brings a quantum hike in tariffs or other headwinds.

Implications for central banks

Improvements in global inflation have opened the door for a sustained easing of central-bank policy. This global cutting cycle has already begun, and we expect it to gather steam through year’s end, as the scope for rate cuts is substantial in many countries.

The Fed is clearly committed to moving policy to a less restrictive stance, with its concerns shifting toward the labor market and growth. We think it’s likely that the coming year will see the Fed take its policy rate down to near 3%, in the neighborhood of the neutral rate (where both inflationary and deflationary pressures are absent). While that’s unlikely to forestall a recession, should one develop, it will certainly provide important support.

The ECB is ahead of the Fed; we expect another cut at its December meeting and another 100 basis points of cuts in 2025, with more rapid moves a possibility. We also expect further cuts from the Bank of England starting in November.

Recent market developments have given the Bank of Japan (BOJ) significantly more room to maneuver in order in crafting policy with an eye on inflation and the domestic economy, without unusual worries about exchange-rate implications. We see the BOJ gradually lifting rates to 1% by the end of 2025.

Emerging markets have followed diverse paths. Many of these central banks began easing policy during the second half of 2023 or early this year. Going forward, we expect rate cuts by the Fed and other developed-markets central banks will broaden the cutting cycles in major emerging markets.