Global briefing: US soft landing?/ China’s charm offensive/ Picking sides in Asia/ De-risking or BAU?/ European heatwaves
In this week’s global briefing:
1. US soft landing?: The US economy continues to perform even as inflation reduces, raising the likelihood of a soft landing. But this week also reminds of the political risks to the US economy, from budgetary decision-making to democratic integrity.
2. China’s charm offensive: The Chinese authorities are projecting a more welcoming business environment, largely in response to a weakening economic outlook. But the Chinese economy remains a challenging environment for Western firms.
3. Picking sides in Asia: As strategic competition builds in Asia, coalition building is stepping up. And this geopolitical positioning is shaping trade and investment flows, with exports to China from Western-oriented economies reducing markedly.
4. De-risking or BAU?: The European policy stance on China has toughened over the past few years. But recent government actions and corporate investments show that progressing the de-risking agenda will be patchy and uneven.
5. European heatwaves: The record heatwaves in southern Europe are an early sign of the costs to come from climate change. But despite this, it has been a record tourism summer in Europe and implementing climate change policy remains challenging.
1. US soft landing?
Recent US economic data provides a measure of confidence that a recession free, soft landing can be avoided. This week’s Q2 GDP data from the US reported 0.6% qoq growth (and 2.6% for the year to Q2). Labour markets remain tight, there is ongoing resilience in consumer spending, and construction spending is booming – partly on aggressive industrial policy.
And the outlook is positive, with interest rates that are likely close to their peaks, and improvements in productivity growth. The latest IMF World Economic Outlook, released a couple of weeks ago, marked up US GDP growth for 2023.
The economic shock of the pandemic was largely supply side in nature. The supply side of the economy is now being pushed out as post-Covid disruptions ease: global supply chain pressures have weakened, labour market pressures are easing after a period of churn (quit rates are down, the ratio of vacancies to unemployed people is easing, and participation rates continue to strengthen).
These supply side dynamics are good for growth and helpful for the disinflationary process. As I’ve noted before, the scale of the pandemic shock and recovery scrambled the informational content of traditional recession indicators such as an inverted yield curve.
And inflation continues to reduce, 3.1% in the year to June, which will limit the need for much more monetary policy tightening. The potential for a relatively soft landing in the US is relatively high: inflation can be tamed without triggering a recession as the transitory elements of inflation fade.
However, this does not mean that inflation will sustainably track back to target (~2%) easily. I have noted before the shift from transitory inflation to wartime inflation: expansionary fiscal policy combined with a fragmenting global economy is likely to create structural inflationary pressures over time (even if largely positive for growth).
However, there are risks to this positive outlook – largely relating to US political institutions. Two of these became apparent this week. First, Fitch downgraded the sovereign credit rating of the US on concerns about the sustainability of the fiscal path (which I discussed recently). This decision was widely panned, but it was not long ago that we were worried about the self-inflicted debt ceiling crisis. My assessment is that a combination of dysfunctional political decision-making and a troubling fiscal path does create meaningful risks. And this week, we have seen interest rates move higher and equity markets sell off.
And second, the return of Mr Trump to the courtroom yesterday on charges of conspiring to stay in office after losing the 2020 Presidential election. These are the most serious charges against him to date, and speak directly to the strength of US democracy and political institutions. It is a reminder of the tension between the structural strength of the US economy and its deeply partisan political system, which creates major economic and political risks.
Implications: Although there are economic risks facing the US, the biggest single cluster of risks relate to political institutions and decision-making. Firms and investors need to monitor whether the extent to which these political risks are compromising the economic dynamism of the US.
The full note is available at: https://davidskilling.substack.com/p/global-briefing-us-soft-landing-chinas