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.
Quarterly Market Review
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Brett Hinds
Jameson Dunn