- Fixed Income Portfolio Manager
Switzerland, Intermediary
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“Jerry: So, he's Bizarro Jerry.
Elaine: Bizarro Jerry?
Jerry: Yeah, like Bizarro Superman. Superman's exact opposite who lives in the backwards Bizarro World. Up is down, down is up. He says hello when he leaves, goodbye when he arrives.
Elaine: Shouldn't he say "badbye"? Isn't that the opposite of goodbye?
Jerry: No, it's still goodbye.
Elaine: Does he live underwater?”
— “The Bizarro Jerry,” Seinfeld, Season 8, Episode 3
During 2023, a resilient US economy stood out as the rest of world struggled with growth. US real GDP rose 2.4%, versus a meager 0.1% increase for the eurozone and a below-potential 4.2% expansion for China. Many economists anticipate a similar outcome this year, with the US again leading global growth, thanks to enduring tailwinds and a robust consumer. Given shifting dynamics, however, I wonder if 2024 might prove the opposite, with US growth lagging a much more resilient world economy.
Why was the US economy so strong in 2023?
The biggest macro event of 2023 was not the Silicon Valley Bank (SVB) crisis in March, but rather Congress’s lifting of the debt ceiling in June. In many ways, the US had been following a typical recessionary playbook until then, with the Federal Reserve (Fed) responding to high inflation by hiking policy rates aggressively over the course of 2022 and into 2023. Deposits leaked out of the banking system, and then the US Treasury yield curve inverted, further disincentivizing lending. By March 2023, the economy was already slowing, and major financial risks materialized with the failures of SVB and First Republic Bank. The extension of the debt ceiling provided an upside surprise in fiscal spending and painted a much more benign liquidity picture, both of which helped propel the US economy through the rest of the year.
With the debt ceiling extended, the US Treasury could now spend freely, and did so, with the yearly deficit peaking at US$2.5 trillion by the end of July. This reckless fiscal spending — done as the economy was growing well above its potential — boosted both consumer spending and corporate profits, allowing the labor market to stay tight.
On the liquidity front, the Treasury was once again able to issue securities, and did so, mainly funding itself via T-bills (notes with a maturity of less than 12 months). Issuing that amount of bonds would usually have been a substantial drain on liquidity, with capital flowing out of bank reserves and into the new issuance. But money market funds had been investing cash at the Fed through a facility called the Reverse Repurchase Facility (RRP). The Treasury’s issuance lured capital away from the RRP and into the T-bill market. This kept bank reserves intact despite the turmoil in regional banks, and the Fed was able to continue quantitative tightening.
Why was the rest of the global economy relatively weak?
Let’s start with China. Despite substantial fiscal measures throughout 2023, China’s pandemic-reopening spending fell short of market expectations, largely because of housing market weakness. Chinese consumers have few options for deploying their savings, with choices limited to a banking system that offers low real rates, a stock market that has been in a drawdown since October 2007, or the property sector. Until recently, real estate was the one area offering consumers decent returns on their capital. When the government began to crack down on speculation, housing prices slumped. It is not surprising that consumer sentiment fell despite continued industrial-sector-led fiscal stimulus. At the same time, China was also wrestling with a depreciating currency relative to the US dollar. Chinese officials, mindful of securing the renminbi’s stability, reduced reserves, thereby shrinking liquidity in the domestic financial system and slowing growth.
Europe’s problems were different. For most of the year, European inflation ran 1% – 3% above US inflation, given lingering effects on food and energy prices of Russia’s war in Ukraine. While inflation took a heavy toll on European real wages, it did not lead to a savings drawdown. This is because, unlike the US, where excess household savings have mostly been depleted since the pandemic, European consumers still have substantial reserves, in part, to buttress their finances against inflation. On the fiscal front, the European authorities showed far more restraint than their US counterparts, delivering a fiscal impulse from EU funds of only 0.3% of GDP.
Why 2024 could be the opposite of 2023
Many of the tailwinds for the US economy in 2023 could reverse. Fiscal spending is unlikely to be as high, given the US election cycle. The US consumer may begin to show signs of strain, and liquidity could become a headache. The Fed’s RRP is draining quickly and may reach a floor by the end of the first quarter. Unless the Treasury decides to spend down its cash balance, excess bank reserves could start to decline thereafter, exacerbating the liquidity crunch.
Importantly, the Fed can (and I expect, will) alter this trajectory. Chair Jerome Powell has expressed support for interest-rate cuts in 2024, if inflation falls back toward the central bank’s target. At the same time, the Fed could curtail its quantitative tightening program even sooner if bank reserves seem scarce following the draining of the RRP facility. Both changes would support the economy and extend growth, but also likely weaken the US dollar.
China could see a brighter 2024, in part because of the Fed’s actions. It could be one of the biggest beneficiaries of a weaker US dollar. The People’s Bank of China would not need to sell reserves to defend the renminbi, thus improving liquidity in the Chinese financial system. Greater liquidity should feed through to the ailing property sector, which would, in turn, boost consumer confidence and spending.
Europe’s cycle is much more tied to China than the US, so a rebound in Chinese growth would help the eurozone’s industrial-led economy. At the same time, European authorities are planning to increase fiscal spending in 2024 to about 0.6% of GDP. Finally, as domestic inflation falls, European consumers’ real incomes should rise. This might finally be the key that unlocks pandemic-era savings and gets Europe’s economy humming again.
Get ready for Bizzaro World in 2024.
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Brett Hinds
Jameson Dunn