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Western Economies are Pivoting to a New Normal While the Rest of Asia Diverges

Jan 08, 2024

2023 had been difficult in the West, as major central banks tightened monetary policy much more than previously expected in light of rampant and stubborn inflation. Interestingly, the impact of such tight monetary policy on growth has been muted, with both the U.S. and the eurozone avoiding recession, especially the former. In Asia, China underperformed growth-wise, compared to the very bright expectations stemming from the end of Covid Zero policies. Many Asian economies, though, overperformed, such as India and even Japan, but those very dependent on exports, especially on ICT and semiconductors suffered from a very negative cycle, especially South Korea, Taiwan and Vietnam.

Asia was also quite special on the inflation front as it remained much more in control. The extreme case was China which is ending the year with deflation on both consumer and, much more so, wholesale prices. This, together with capital controls has allowed the PBoC to follow its own needs in terms of monetary policy, with small cuts rather than hikes as the rest of the world utilizes. The other exemption is also in Asia, namely Japan, but with a twist: with inflation over 3% but rather stagnant wages, the Bank of Japan has been dragging its feet to move out of negative rates, which has led to a record weak yen.

In 2024, the scenario will be very different as disinflationary forces in the West have been in place for a few months and are bound to continue so that both the U.S. and the eurozone should reach their inflation objectives by year-end. This means that the Fed and the ECB should have the necessary room to cut interest rates quite rapidly, possibly 150 basis points for the first and 125 basis points for the second. The reduction in funding costs should help avoid a hard landing but also the restoration of purchasing power by households which should see their real disposable income rise as inflation falls. This means that no hard landing should be expected for the U.S., with growth hovering around 1.2% from an impressive 2.4% in 2023, against the odds. The eurozone should manage to increase growth for the very low 0.5% this year to a level similar to that of the U.S. (1.2%). This rather positive scenario for the eurozone stems from the rather positive energy outlook with gas storage facilities at 97% capacity two months into the winter, the surge in installation of renewable energy, and warm temperatures.

At the same time, the Chinese economy will continue to decelerate from about 5.2% in 2023 to 4.5%, on the back of limited fiscal and monetary support. India, instead, will continue to shine with 6.5% growth in 2024, an important election year for the country. Those countries hit by the ICT/semiconductor cycle should also do better next year as the inventory cycle comes to an end.

Given much lower Fed rates and a decelerating U.S. economy, the U.S. dollar is set to weaken in 2024 at around 1.13 against the euro. That trend should be more extreme against the yen since the BoJ is expected to exit its negative rate policy by the end of the first semester. This also means that 2024 should lead bonds to outperform equities as yield curves steepen. In addition, interest rates might not be lower in real terms as inflation moderates rapidly, which will put additional pressure on issuers. The piling up of debt, especially at the government level, since Covid, points to the growing difficulties in serving debt with potentially higher interest rates. 

All in all, 2024 will be the year when central bank key policy rates will start to subside thanks to lower inflation. Gains in real income, among other factors, should lead us to a soft landing in the U.S. and the eurozone while China continues to decelerate although still contributing relevantly to global growth. This rather positive scenario is subject to several risks, starting from geopolitics. Good examples are elections in the U.S. as well as Taiwan but also complications in the two ongoing wars. On the economic side, such an elegant soft landing could be disrupted by different shocks, starting with a sudden deterioration of investors’ mood due to a geopolitical event. The Taiwan elections in early January are surely a first test but also increasing tensions between China and the Philippines in the South China Sea. Later in the year, the US elections, with the potential return of Trump as an added complication, is a major event to watch. Finally, risks stemming from China’s real estate sector which keeps on adjusting to financially impaired local governments should not be underestimated.   

All in all, 2024 is a year of normalization of inflation and monetary policy in the West with a still divergent Asia. It is also a year of major risks, from Taiwan and U.S. elections to the Chinese economy.

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