The Global Economy Is Surprisingly Strong, but Growth Is Likely to Slow

But the global economy has defied the laws of economic gravity. Global growth outperformed our expectations last year, with consumers simply refusing to quit spending. U.S. growth posted a particularly large upside surprise, with 2.5% real growth for the year, as the economy shrugged off the effects of Federal Reserve rate hikes. Similar surprises were recorded in Mexico and Brazil. Although overall growth in the euro area was anemic, the services-intensive countries in the south—such as Spain, Portugal, and Greece—look to have registered solid 2 to 2½% growth. All told, global growth put in a solid near-trend performance.

Markets have enthusiastically welcomed this good performance, with the S&P 500 recently touching an all-time high. However, as an economist and a practitioner of the “dismal science,” I continue to see some lingering reasons for concern. 

First, many of the lagged effects from tighter monetary policy are still in the pipeline. Countries where rates on existing mortgages rapidly adjust have already felt the blow. Sweden, which entered recession in the third quarter, is a prominent example. But other countries, such as the United States, will feel increased restraint as higher rates and tighter lending conditions continue to play through. Even if the Fed and other central banks begin to cut rates as the year progresses, it’s unlikely to reverse these headwinds. 

Second, the coming year should see the global consumer take a breather. Coming out of the pandemic, consumers sought to replace services experiences that were lost during the pandemic. However, this surge in services-oriented spending now looks largely complete, and the pace of services expenditures is likely to step down. 

This slowing in services spending should also bring a loosening in labor markets and cooling in wage gains. This softening will restrain global growth but, importantly, it will also help take the heat out of global inflation. Central banks are not targeting higher unemployment rates, but history suggests that looser labor markets may be necessary to bring inflation sustainably down to the target. 

Third, significant geopolitical challenges are in play. The Russia-Ukraine war is grinding into its third year. More recently, tensions in the Middle East have disrupted global shipping routes, which has brought longer transit times and higher shipping costs. The upshot is increased pressures on goods prices and global supply chains. To date, the oil market has absorbed the stresses in the region surprisingly well, but the risks of abrupt price increases are rising as well. 

In addition, the year ahead brings literally dozens of national elections, which will frame economic policies and geopolitical realities for years to come. Of these, the U.S. presidential vote will no doubt be front and center. The U.S. electorate remains deeply divided, and the campaign will be loud, intense, and bitter. The ebb and flow of political developments is likely to be a source of market volatility, especially in the back half of the year.

Finally, the global manufacturing sector has languished through the post-pandemic period, as consumers have spent vigorously on services. With services spending expected to step down, manufacturing could see a bounce. Even so, the outlook remains cloudy. Last year, the goods sector in the U.S. and Asia showed some signs of life, but this momentum never broadened or fully carried through. This issue will be critical for large manufacturing-intensive countries such as Germany and China.

For all these reasons, we expect that the global economy will register a broad-based slowing this year, with essentially all major economies stepping down from last year’s pace. Countries that recorded relatively strong performances in 2023 (including China and India) are likely to slow a notch. Those where growth was weak (including Germany, the U.K., and Sweden) are expected to remain weak. And countries that enjoyed upside surprises (including the U.S., Mexico, and Spain) should see growth soften. 

If there is any upside, it’s that this slowing of global growth should support central banks’ efforts to bring down inflation and, as the year progresses, create room for rate cuts.

Bottom line, last year we failed to fully appreciate the entrenched resilience of the global consumer. And perhaps we are guilty of making the same mistake again. But one of the fundamental laws of both biology and economics is that trees don’t grow to the sky. And the practical corollary is—if something appears to be too good to be true, it probably is. 

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