Global H2-23 Outlook Podcast – Balancing on the summit
The desk interprets the current economic landscape as a precarious balancing act for the US, with the potential for recession looming amidst tight monetary policy and persistent inflation. Per the full note source, while the US banking sector may have stabilized, the broader economic challenges remain significant, particularly as growth expectations pivot towards emerging markets like India and the ASEAN region. This shift suggests a recalibration of risk and opportunity in the FX space, particularly for currencies tied to these emerging economies. Our consensus targets reflect a cautious outlook, with a focus on how these dynamics will influence currency movements in the second half of 2023.
What the desk is arguing
The desk frames the current economic situation as a critical juncture for the US economy, where the worst of the banking crisis may have passed, yet the specter of recession persists due to tight monetary conditions and ongoing inflationary pressures. Per the full note source, the shift in growth prospects towards emerging markets indicates a potential reallocation of capital that could impact currency valuations significantly.
Supporting this view, Standard Chartered highlights that the US economy is grappling with stubborn inflation rates, which remain above the Federal Reserve's 2% target, complicating the monetary policy landscape. The latest Consumer Price Index (CPI) data shows inflation at 3.7% year-over-year, underscoring the challenges ahead.
Where it sits in our coverage
Our consensus target for the USD/EUR pair is set at 1.075, with a range between 1.04 and 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This perspective aligns with jpmorgan, which sees a stronger dollar in the medium term, while bofa presents a more bearish outlook, suggesting a divergence in expectations regarding US economic resilience and inflation control.
How other firms see it
Firms like jpmorgan and goldman are aligned in their bullish outlook on the dollar, anticipating that the US economy will outperform in the face of global challenges. Conversely, bofa and citi have adopted a more cautious stance, predicting potential weakness in the dollar as emerging markets gain traction.
Key currency pairs to monitor include USD/INR and USD/SGD, as movements in these currencies will likely reflect the shifting growth dynamics and investor sentiment towards emerging markets.
What the calendar says
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Hello, I'm Aneesha Tank. Welcome to this special podcast from the Global Strategy Team at Standard Chartered. The latest global economic outlook for the third quarter of 2023 is out, and this time it's called Balancing on the Summit.
Whilst the worst might be over in the US banking sector, there is still an unease over the resilience of the world's largest economy in response to stubborn inflation and the limitations of monetary policy. So we're going to ask what's in store for the US? Is it possibly staring down a recession?
Then the focus shifts to where there is more impressive growth to speak of, China, India, and Southeast Asia. Growth engines appear to have shifted east. So what does this mean for our evolving paradigm underpinning global growth?
Joining me to discuss these issues and plenty more, we have Eric Robertson, Global Head of Research and Chief Strategist at Standard Chartered, and also Kaushik Rudra, Global Head of Fixed Income Research and Head of Asia Research. Eric, I'm going to ask you to just take stock for us of the global growth outlook as a whole. As you know, we have been very focused on this idea of divergence under the surface.
One of the things that has really resonated with us over the last couple of weeks as we prepared this outlook is that this idea of divergence seems to be even more relevant today than it was three or six months ago. Global growth is what I would call substandard. So we have a forecast of still less than three percent growth for this year and for next.
But I think diverging stories in the global economy are really what's a lot more interesting. US, Europe, UK struggling under the weight of monetary tightening, some more than others. But as we look around the world, there is definitively a shift east.
We have very good growth momentum in ASEAN. We have very good growth momentum in India and parts of the GCC. China is the big question mark.
We have seen a slight deceleration from peak growth momentum earlier this year. And I think the question for H2 is where does China come out in this puzzle? I want to zero in on something you just said.
You talked about substandard growth. And that made me wonder whether there is this sort of level of expectation that we should or perhaps should not have. When you say substandard, what are you really talking about?
For global growth below three percent, you start to have some concerns about how much of a buffer there is between a growth trajectory and a recession trajectory. Now, if you talk about the U.S. for a moment, it's been very resilient over the last six months, even with all of the monetary tightening that's been put through the pipeline. The European economy seems to be starting to struggle under the burden of tight financial conditions.
And the U.K. is doing a similar thing. If we think about the U.S. and perhaps the rest of developed economies as we move into the second half of the year, I think a really critical point will be whether we slow to a point of really low growth or if we actually do dip our toes into a contraction or recessionary territory. Let's go back to divergence, because if we're talking about three percent, given what we expect from the U.S., which is much lower, it's a really different story.
You've already talked about divergence for what we expect from some of these economies in Asia. Gaushik, let me bring it to you. Is it wishful thinking to assume that the Asia story is going to be what keeps global growth resilient?
I think global growth is going to be weak, and that's primarily being driven by what we're seeing in the developed market space. I think the growth over the next six months and then into 2024 will be quite weak. By contrast, EM growth will actually be much stronger.
I think there's going to be a lot of divergence within emerging markets as well. But Asia clearly is underpinning that EM growth and lifting that global growth number as well. Our expectation of a global growth this year is 2.7 and 2.9 for next year, so not very stellar growth.
But against that backdrop, Asia is going to see growth rate above five percent. And you have a number of countries in Asia within the ASEAN region, Indonesia, Vietnam, Philippines, all above five percent. Thailand and Malaysia grow in excess of four percent.
India, of course, is doing very well. It's clearly the leader right now. Strong domestically driven growth, real opportunity for India to stand out as being one of the fastest growing large economies of the world.
Clearly, domestic demand is very robust. Manufacturing activity is very strong. There is a capex recovery taking place, all of which should sort of underpin India's growth.
One piece which is not humming as well as it normally does is China, right? I mean, China, unlike in previous times, is not necessarily leading the recovery. We'll still get decent growth rate.
We're talking 5.4 percent this year, which is good, but disappointing versus where expectations were earlier in this year. So I think we are not necessarily seeing the investment spend, the real estate activity that China has had, and that's resulted in positive spillover effect for rest of Asia. They're not necessarily relying as much on China as they've typically done.
Yeah, that's really interesting, actually. Eric, U.S. 2024 GDP growth forecasts, standard charter does come in below consensus, according to this report. Why?
There is this elephant in the room of the cumulative amount of monetary tightening. There's also the emerging tightening of the Fed's balance sheet or the shrinkage of the Fed's balance sheet. And all of this has happened at nearly an unprecedented pace over the last 18 months.
It is our belief that the tightening of monetary conditions in the U.S. and globally is going to start to have an impact on the labor market, which in turn will have an impact on consumer spending. Now, it may not be a cliff edge event. In other words, it may not be a collapse in economic activity.
In fact, I would suggest it's probably not. But I do believe that the U.S. economy is due a reversal from its previous peak performance. Now, the question of whether we go into a recession or not, I think, is largely technical.
I think by the time we get to the end of this year and into early next year, we will see some sectors that are really struggling under the weight of these tighter financial conditions. We've already seen an increase in debt defaults in the private sector. We've seen an increase in bankruptcies.
We're seeing an increase in credit card usage, which suggests a drawdown in savings. So it does appear to us, even though the data has been quite slow to show it, there's quite a bit of softness under the surface and it's still working its way through the system. I'm very curious how long the banking sector can withstand some of these pressures that you're talking about.
Can I just get your reflection on that? I think many people succumbed to the idea back in March that the U.S. banking sector was under some sort of a systemic threat. That was not our view.
Our view was that this would lead to a slow deterioration in credit conditions. We have seen that. We believe there are a number of smaller regional banks or community banks that will suffer from higher interest rates and the impact on their balance sheets.
But the larger parts of the banking system, what we call the systemically important banks, are extremely diversified in terms of their deposit base. They're extremely diversified in terms of their assets and liabilities. And so I think the banking sector overall is probably in relatively good shape.
Now, the challenge is we have a deeply inverted yield curve that presents all kinds of challenges for interest rate risk management. And so I think it would be naive to assume that the banking sector is free and clear. But I think the right way to describe this is as a cyclical downturn in profitability due to credit conditions rather than some sort of systemically threatening event.
I know, Gausik, you had some views on this as well. I think the deposit outflows from the regional banks that we saw earlier in the year will perhaps have a lasting impact on them and on the sectors that they lend to. Regional banks represented around 25% of all lending in the US.
The sectors that they most lend to are the commercial real estate space and the SME space, both fairly large employment generators as well. These sectors were relying on these regional banks to lend to them. The regional banks have a truncated balance sheet because of the deposit loss, and hence their ability to lend to these sectors is somewhat challenging.
Now, if they don't lend to these sectors, borrowers in these sectors will come under more pressure. They could perhaps default. This hits back the bank again as loan losses.
So the banks will have to provision for them, and this will eat into profitability of these banks. Now, larger banks recently have already reported higher losses in their CRE portfolios. So we will see that play out over the coming quarters.
And as this system stress seeps through on the regional bank side, perhaps there's going to be more pressure on US growth outlook coming from that channel. What's your thinking about sentiment and how much of that is influencing these robust growth hopes that we have for Asia and for EM more widely? To what extent are they pinned on US performance or the sentiment around the world's largest economy?
Given the slowdown we are seeing in the US and in Europe, I think trade is clearly going to be under pressure. This means more pressure for countries that are more dependent on external trade. The more open economies of Asia will clearly be vulnerable.
But that said, I think a number of the Asian economies are clearly expanding on domestic factors. Domestic consumption remains very healthy. Internal capex has been very healthy.
And there's a strong investment coming via the FDI channel. So Asia is seemingly more resilient right now to what is happening in the US. Okay, let's look at some other challenges.
One of the big challenges has been inflation. What is the firepower of the Fed in the US to get inflation under control? Even the ECB is struggling with this in Europe as well.
And then in the US, if we bag this up with this declining dollar story, don't we have a bit of an inflationary double whammy? There are so many inputs into this inflation question, food prices being one, energy prices being another. We are seeing a decline in inflation pressure around the world at the moment.
Latin American inflation has come down off the highs. That's a very important signal in our opinion, because LATAM was an early warning of the uptick in inflation two years ago. We have very low levels of inflation and in some cases, outright deflation in China.
The US, Europe and the UK are struggling with the fact that manufacturing inflation has come down, but services inflation remains elevated. So there's all kinds of implications of that. Now, one of the tricky things is that inflation released by the government statistics office is coming down.
But for the person on the street who are still seeing very elevated food prices and cost of living adjustments, there's a growing disconnect, right? I think the good news is that we are seeing some softening in wage inflation pressure. That will be very important going forward.
We are seeing a significant improvement in supply chains that will make the cost of delivering these goods, whether it's food or energy, more palatable. So I think there are some inputs into the inflation narrative that are more friendly. But I think the real question as we look into the future is what is the structural level of inflation where we will settle at?
And I think that's probably going to be higher than where we were pre-COVID. EM inflation, even though this is being described as better behaved, as we know from the report, we're still talking about economies with heavy dependence on commodities, for example. We're still talking about countries which are going to be at the forefront of climate change and need huge infrastructure build out.
All of this is going to cost money. Eric has mentioned that and that structural inflation is on the rise. So how is all of this affecting the story for EM?
Inflation has been a challenge for all countries, but on the emerging market side, there's been a little bit more supply aspect to this inflation than what we've seen in the developed market side. Now, some of the things that you mentioned are structural. The central banks will be cautious in the way they approach this whole thing.
They will probably not hurry to cut rates immediately. They'll want to see clear evidence of the Fed and ECB starting to cut rates. They would want to see their own inflation trajectory come down before they feel comfortable bringing down rates in a more meaningful way.
What would be the opportunities for EM? Well, I think the opportunities clearly are getting set up on the EM local currency side. When we think about real rates in emerging markets and compare that to DM real rates, I think EM real rates were not very attractive.
Now that's starting to change with inflation starting to come down in emerging markets. The second aspect is the dollar is now starting to become weaker. Now, if that continues to happen on a sustained basis, those are the two headwinds against EM local currency.
This is an asset class that people have loved to hate. And I think with sentiment shifting, you could potentially see people coming back into the asset class, which would be wonderful news for a lot of these markets, particularly as their reliance on funding shifts from external dollar funding to their domestic currency. So I think that will help a lot of governments as well.
I got a big sign of acknowledgement there from Eric when you were mentioning the dollar. Eric, go on. Dollar weakness, I think, would offer not only an enormous amount of relief to local currency markets in Asia, but I think would present a number of opportunities.
Now, it is our view that the dollar will weaken on a cyclical basis, but we don't subscribe to the view of a structural debasement of the dollar. But what I think is really crucial here, if we have the Fed nearing the end of its rate hiking cycle and you see inflation coming off the boil in the US and some other markets, some of that risk premia that has been embedded in EM local currency markets, either on the rate side or the currency side, should start to come out of the equation. And I think you're left with some very attractive opportunities in Asia, local currency, the idea of a decline in US rates and US rates volatility typically is a very, very positive sign for a shift in capital flows back into EM.
Is there anything else that we need to mention on the economic side that you think we need to be mindful of? Eric, you go first. I think China is a really critical question mark.
We have had a decent recovery in economic momentum in China this year from the COVID-related lockdowns 2022. But over the last couple of months, growth momentum has been a little bit disappointing relative to people's expectations. But 2024 has a big question mark.
Will we see an increase in consumer spending in China? Will we see an improvement in labor market prospects, especially for young people coming out of university? Will we see a resurgence in the private sector?
There are a number of emerging sectors in China's economy like alternative energy, solar, EV, that are making enormous gains, but they're still a relatively small portion of the overall economy. So this tension, this tug of war between new economic trends versus some of the underwhelming performance in older sectors, I think is a key driver for China and for Asia over the next couple of years. This is really around something in the report that I found fascinating.
The question, is the world getting more fragmented? So obviously, during COVID, we saw a lot of fear around the realizations that when something breaks in your supply chain, it affects everybody, right? And then we're also seeing the scramble for resources and the net zero transition.
I mean, these are just a couple of factors that are beginning to play into forward thinking. I'm curious, Eric, why did you feel the need to ask this question about fragmentation? There has been a lot of discussion in the last couple of years about whether globalization is over, and have we now shifted permanently in the direction of de-globalization?
As a team, we don't believe it's such a simple or binary answer. It encompasses a number of different themes. It's U.S.-China trade wars.
It is geopolitical tensions, whether in certain hot spots in the Middle East, whether it's Russia-Ukraine, whether it's U.S.-China. And then, as you correctly pointed out, it's the response to COVID and the impact that that had on supply chain resilience. What we believe is that there are a number of factors that will contribute to a more fragmented global economy.
The competition for natural resources or natural resource nationalization is a key risk. That's energy security, that's food security, water security, and semiconductor security. There's also this idea that there are supply chains that are growing and that actually are a positive in this overall story.
We've seen a big pickup in economic activity and flow between the GCC and various parts of Asia. So we're seeing a shift in supply chains, which I think is a bit contradictory to this idea that globalization is over. The reality is that as these supply chains shift and as supply chains are rebuilt to be more resilient, there is a cost to that.
There's a frictional cost of building that resilience. There's a frictional cost of building natural resource buffers against future conflict or future tension. No matter what side of the debate that you come down on in terms of globalization, there's a risk to higher inflation and a risk to higher cost of doing business that I think we need to be aware of.
On that front, Gorsuch, is there a rebalancing effort from Global North to Global South, do you think? Is that going to be a feature of shifting growth economics as we start looking out even as early as 2024? Clearly, I think there is a shift.
When we think about the next few years, it definitely feels like emerging markets will be powering the engine of the global growth story. Asia will continue to do well. GCC, I think there is a clear diversification play happening from a medium-term perspective.
The non-oil sector will be the engine that results in the region doing very well. LATAM clearly has challenges ahead but is very well positioned, having done well on the inflation front, done well on the policy front. Africa clearly has challenging times but has embraced reforms, which is a very good thing to see.
And I think that should help the region rid itself of some of the pressures that it faces from subsidies. So, things are looking up for the South, for emerging markets on both relative and outright basis. Okay, well, that's a great place to leave it up, even though we know there is this story of divergence and completely agree with this idea of discussing the fact that things are shifting.
Thank you, as always, to Eric Robertson, Global Head of Research and Chief Strategist, and Gorsuch Rudra, Global Head of Fixed Income Research and Head of Asia Research. I'm Aneesha Tank from the whole production team. Goodbye.