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Economic outlook: US powers global growth
Darrell Spence
Pramod Atluri
Fixed Income Portfolio Manager
Brad Freer
Portfolio Manager

The United States, flexing its muscles as the world’s largest economy, is once again serving the critical role of global growth engine. As Europe and China struggle with weak economic activity, the US, India and, to a lesser extent, Japan are showing signs of resilience as the major players in the world economy diverge.

Despite higher interest rates and elevated inflation, the International Monetary Fund is predicting the US economy will expand this year at more than twice the rate of other major developed countries. The IMF recently raised its forecast for US growth to 2.7%, compared to 0.8% for Europe. Moreover, the power of America’s consumer-driven economy is helping to support growth in the rest of the world as well.

“People used to say if the US sneezes, the rest of the world catches a cold. The opposite can also be true,” says Capital Group economist Darrell Spence. “When firing on all cylinders, the US can help other export-oriented economies.”

US and India generate strong tailwinds for the global economy

Displayed are the economic conditions of various countries and their impact on the global economy. There are two axes. The horizontal axis is labeled “near-term headwinds” at the far left and ”near-term tailwinds” on the far right. The vertical axis is labeled “long-term tailwinds” at the top and “long-term headwinds” at the bottom. Circles to the top or bottom of the horizontal axis or to the left or right of the vertical axis represent countries. The size of the circles indicates the relative strength or weakness of each country’s economy. The United States, India and Japan are positioned toward ”resilient growth” and ”near-term tailwinds,” suggesting they are generating strong positive momentum for the global economy. In contrast, China is closer to ”fragile growth” and ”near-term headwinds,” while the European Union, Australia, Canada and the United Kingdom are scattered between “fragile growth"and “long-term headwinds.” The European Union is shown primarily in the “fragile growth” quadrant with a partial segment in the upper left quadrant.

Source: Capital Group. Country positions are forward-looking estimates by Capital Group economists as of April 2024 and include a mix of quantitative and qualitative characteristics. Long-term tailwinds and headwinds are based on structural factors such as debt, demographics and innovation. Near-term tailwinds and headwinds are based on cyclical factors such as labor, housing, spending, investment and financial stability. The size of the bubbles are used to approximate the relative size of each economy (in USD) and are for illustrative purposes only.

Spence is more optimistic than the IMF. He believes the US economy will grow at a rate closer to 3.0% this year as consumers continue to spend, the labour market remains tight, and manufacturers invest in newly diversified supply chains. Meanwhile, recession fears — widespread just a year ago — are no longer a given.

“Most people would have thought that after the Federal Reserve raised interest rates as aggressively as they did, the US would be in the middle of a recession right now,” Spence adds. “It is surprising, to myself included, that we haven't seen more economic weakness.”

Inflation is falling but stalling

Looking ahead, much depends on the path of inflation. The US economy has continued to grow in the face of elevated inflation and a federal funds rate currently at a 23-year high. It now sits in a range of 5.25% to 5.50%, up from near zero roughly two years ago.

“The U.S. economy has adapted well to this new rate environment,” says Pramod Atluri, a fixed income portfolio manager.

The Fed’s battle against inflation has made significant progress, helping push consumer price increases down from 9.1% in June of 2022, to a range of 3% to 4% over the past few months. However, that is still above the Fed’s goal of 2%, a fact that calls into question whether the central bank will cut rates this year or stand pat. Based on their public comments, Fed officials appear biased toward cutting.

Inflation is declining around the world, but does it justify rate cuts?

A dual-panel line graph displays trends in the annual change in the Consumer Price Index (CPI) on top and policy rates across four regions: United Kingdom, United States, Eurozone and Japan on the bottom between January 31, 2020, and April 30, 2024, with estimates shown through January 2026. The top panel, labeled “Annual change in CPI (%),” shows a peak of inflation around early 2022 followed by a downward trend for all regions. The United Kingdom peaks at 11.05%, the United States at 9.06%, the Eurozone at 10.6% and Japan at 4.30%. Dotted lines represent future estimates, which continue the declining trend for all regions except Japan that shows slight increases post-2024. The lower panel, labeled “Central bank policy rates (%),” depicts an upward trajectory for all regions with market implied policy rates suggesting increases over time. The United Kingdom starts at 0.75%, rising to 5.25%; the United States starts at 1.75%, rising to 5.50%; the Eurozone begins at negative 0.50%, climbing to 4%; and Japan begins at negative 0.10%, climbing to 0.10%. The graphs indicate that while inflation (CPI) is on a decline, policy rates are on the rise, which could suggest that rate cuts may not be justified based on this data alone.

Sources: Capital Group, Bloomberg Index Services Ltd., FactSet, International Monetary Fund (IMF). Inflation data as of April 30, 2024, except for Japan data which is as of 31 March, 2024. IMF estimates as of April 2024. Policy rates represent the rate on overnight interbank lending. Inflation data is expressed using the Consumer Price Index (CPI), a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Market-implied policy rates are based on contract pricing across futures markets and are as of 23 May, 2024.

Fed Chair Jerome Powell has identified two paths to rate cuts: unexpected weakness in the labour market or inflation moving sustainably down to 2%. As Powell often states, Fed policy remains “data dependent.”

Atluri is optimistic that price increases will fall closer to the Fed’s target in the second half of this year. That is largely because rent increases — a major reason core inflation remains elevated — continue to modestly improve.

Elsewhere in the world, growth and inflation expectations are weaker than in the US, and central banks are expected to cut interest rates more rapidly. Europe is struggling with economic growth below 1%. China’s economy, hit by a major downturn in the real estate market, is showing signs of additional weakness as the world’s second largest economy reaches a level of maturity after nearly 30 years of uninterrupted growth.

Emerging markets: India on the rise

In contrast, India has emerged as a bright star in the emerging markets universe. India’s economy is expected to grow at a rate of 6.8% this year, according to IMF projections. And its stock market has provided some of the best returns in the world over the past few years, based on the MSCI India Index.

As the post-pandemic world adopts new and diverse supply chains, many companies are looking to India as an additional source of manufacturing capacity as China’s economy matures. For instance, India has become a viable alternative when it comes to manufacturing mobile phones, home appliances, pharmaceuticals and other products traditionally associated with China’s manufacturing base.

China and India: A tale of two evolving stock markets

A line graph showing the country weight in the MSCI Emerging Markets Index, expressed as a percentage, from 2001 to 2024. There are two lines, one representing China and the other India. The x-axis indicates the years, while the y-axis shows the percentage weight from 0% to 45%. China’s line starts at 5.40% on January 31, 2002, increases sharply to peak at about 43.24% by October 31, 2020, then declines to 25.13% on March 31, 2024. India’s line begins at 5.68% on January 31, 2002, and gradually increases over time to 17.70% on March 31, 2024. A shaded area beginning in late 2020 and ending on March 31, 2024, highlights India’s rise and China’s fall.

Sources: MSCI, RIMES. Data reflects 31 January, 2020, to 31 March, 2024.

The rise of India also speaks to a larger trend in other emerging markets. Infrastructure growth is accelerating, new manufacturing hubs are boosting regional economies, and the world’s energy transition is driving foreign investment into a broader mix of developing countries.

“The setup for emerging markets is attractive,” says Brad Freer, an equity portfolio manager. “As multinationals diversify their supply chains, this is an exciting opportunity for countries such as India, Mexico and Indonesia because it broadens the investable options for manufacturers in the US and Europe. Meanwhile, a deep selloff in China has created opportunities to selectively invest in companies with strong cash flows and dominant market share.”

On top of that, most emerging markets are trading at their cheapest valuations on a price-to-earnings basis in 10 years, Freer notes, and central banks in many developing countries have ample room to cut interest rates.

US presidential election: The world is watching

Elections are taking place throughout the world this year, but none will be more closely watched than the November rematch between incumbent US President Joe Biden and former President Donald Trump. The result could produce a significant shift in political leadership, potentially triggering policy changes that could affect the investment environment, both in the US and globally.

A great deal depends on whether the winning presidential candidate will muster enough support to propel other candidates in his party to victory, taking control of the US Senate and the House of Representatives in a red wave or blue wave scenario. Otherwise, gridlock could prevail, with little change expected. However it plays out, investors should expect occasional bouts of market volatility in the months leading up to Election Day.

How US elections could impact financial markets

Comparative tables showing the potential impact of U.S. elections on financial markets. The table at left represents the potential beneficiaries of a Republican red wave, while the table at right represents the potential beneficiaries of a Democratic blue wave. Under the red wave the sectors that might benefit are: banks and financials, which could benefit from weaker regulation and lower capital requirements; aerospace and defense, which could benefit from a proposed increase in spending; health care, which could benefit from proposed deregulation, promoting competition and efficiency, but this could also lead to lower prices and profits; oil and gas, which could benefit from domestic drilling and mining being encouraged and deregulated, but could result in a lower price per barrel. Under a blue wave the sectors that might benefit include renewable energy and electric vehicles, which could benefit from increased protection of the Inflation Reduction Act (IRA) and stronger environmental regulations; telecommunications, which could benefit from the expansion of broadband funding; homebuilders and industrials, which could benefit from increased immigration, keeping wage inflation low; tech and manufacturing, which could benefit from continued stimulus support from the IRA and CHIPS Act. The tables represent a general overview of potential U.S. election trends based on the research of Capital Group’s Night Watch team, a group of economists, analysts and portfolio managers.

Source: Capital Group. CHIPS Act refers to the Creating Helpful Incentives to Produce Semiconductors Act, passed by U.S. lawmakers in 2022 to encourage domestic manufacturing of computer chips. 

A Republican sweep, or red wave, could benefit banks, health care companies, and oil and gas companies, primarily through deregulation, according to Capital Group’s Night Watch team, a group of economists, analysts and portfolio managers who track such issues. A Democratic sweep, or blue wave, could provide a boost to renewable energy initiatives, industrial stimulus spending and telecommunications projects through additional funding for nationwide broadband access.

As for the presidential election, it remains too close to call. “We’re still a few months away,” says Capital Group political economist Matt Miller. “And that’s a lifetime in politics.”

Darrell R. Spence covers the United States as an economist and has 31 years of industry experience (as of 12/31/2023). He holds a bachelor’s degree in economics from Occidental College. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics.

Pramod Atluri is a fixed income portfolio manager with 25 years of industry experience (as of 12/31/2023). He holds an MBA from Harvard and a bachelor’s degree from the University of Chicago. He is a CFA charterholder.

Bradford F. Freer is an equity portfolio manager with 33 years of investment industry experience (as of 12/31/2023). He holds a bachelor’s degree in international relations from Connecticut College and is a CFA® charterholder.

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