Goldman Sachs 2024 Global Macro Outlook: The toughest is behind us

A 100,000-word article: The Dawn After the Dark for Global Economy

After experiencing radical interest rate hikes, slowing economic growth, geopolitical conflicts, and oil production cuts, Goldman Sachs believes that the darkness before dawn has passed.

On November 8th, Jan Hatzius, Chief Economist of Goldman Sachs, and his team released the 2024 Macro Outlook Report. They believe that the global economy has performed better than their optimistic expectations this year, and growth will remain strong in 2024, with inflation continuing to decline, and the tightening cycles of major central banks around the world have peaked.

They believe that the "last mile of reducing inflation" is not as difficult as it seems, and it does not actually require an economic recession, or even more interest rate hikes:

We still believe that the risk of an economic recession is limited, and we reiterate that the possibility of a US economic recession is 15%.

We expect several favorable factors for global economic growth in 2024, including strong real household income growth, less drag from monetary and fiscal tightening, a recovery in manufacturing activity, and an increased willingness of central banks to cut interest rates when economic growth slows down.

However, despite believing that interest rates have peaked, Goldman Sachs states that rate cuts may not come until the second half of next year, and the ultimate policy rates may be higher than current estimates:

Most major central banks in developed countries may have completed interest rate hikes, but based on our benchmark forecast of a strong global economy, rate cuts may not come until the second half of 2024.

When interest rates eventually stabilize, we expect central banks around the world to maintain policy rates above the estimated level for long-term sustainability.

Goldman Sachs expects the Bank of Japan to exit its Yield Curve Control (YCC) policy in the spring of next year and officially tighten and raise interest rates in the second half of next year.

In terms of assets, Goldman Sachs expects the US dollar to still have upside risks, but the returns of interest rates, credit, stocks, and commodities may exceed cash. "A more balanced asset portfolio" will replace cash as the market focus next year.

2023: Beyond Expectations

Goldman Sachs believes that the global economy has already exceeded their expectations this year, and the unexpected negative impacts have not had a significant effect on the overall global real economy.

We now estimate that global GDP will grow by 2.7% this year, which is 1 percentage point higher than Bloomberg's general forecast a year ago. Based on GDP weighting, the performance of 88% of the economies we cover will be better than expected.

Steady GDP growth has translated into more robust labor market performance:

The unemployment rates of all economies covered by us that generate high-quality labor market data have continued to decline slightly from 2022 to 2023, currently about 0.5 percentage points lower than the pre-pandemic level.

Importantly, this improvement is evident even in major economies such as the Eurozone, where actual GDP growth is very low.

In addition, Goldman Sachs also points out that the efforts of major central banks around the world to combat inflation have been underestimated, and they are actually close to their targets:

Since the end of 2022, the continuous core inflation rates of all G10 economies, except Japan (which hopes for inflation to rise), have dropped from 6% to 3%. Therefore, it can be seen that central banks have already completed more than three-quarters of the adjustments needed to bring inflation back to target.

This improvement is widespread across economies. In our observations, inflation in each economy has shown significant and meaningful declines from its peak in most cases.

2024: "The Last Mile"

Now that major central banks around the world have completed three-quarters of the work to lower inflation, there are views that the "last mile" of inflation reduction will be more stubborn and difficult than before. However, Goldman Sachs disagrees.

"We do not believe that the last mile of reducing inflation will be particularly difficult," Goldman Sachs said.

Their reasoning is mainly based on the fact that the decline in commodity inflation has already been largely completed, with only core goods inflation remaining, which may take a significant portion of time in 2024 to complete.

Secondly, there is still room for a further substantial decline in housing inflation, but owner-occupied housing has been excluded from key inflation indicators.

Most importantly, the supply-demand balance in the labor market continues to improve.

"The gap between job openings and workers, measured by subtracting the number of unemployed workers from job vacancies, is declining everywhere," Goldman Sachs said.

In theory, this improvement could occur in a benign way, with a decrease in job vacancies, or in a more harmful way, with an increase in the unemployment rate.

In reality, so far, this adjustment has been almost entirely benign, as job vacancies have decreased without an increase in the unemployment rate.

Therefore, Goldman Sachs expects that this "progressive rebalancing" of the labor market will not bring about significant pain:

"The job vacancy rates in most major economies are still high relative to what economic fundamentals imply (hence there is further room for normalization), and considering that inflation is currently below central bank targets, it may not need to fully reverse to pre-pandemic levels."

Given this improvement and the sharp decline in overall inflation, nominal wage growth has started to slow significantly, so it is not surprising that it is returning to levels consistent with the target. Coupled with generally anchored inflation expectations, "this suggests that the early surge in inflation is unlikely to have significant second-round effects."

As it will still take nearly a year to lower core inflation, Goldman Sachs points out that there is indeed "room for further development" of an economic downturn:

"On average, we expect consecutive core economic growth to slow in G10 countries and emerging markets, excluding Japan. We expect the core inflation rate to decline from the current 3% to a range of 2.2-2.5%, which is roughly in line with the inflation targets of most developed country central banks by the end of 2024."

"If there is any difference, we believe that the risks of achieving inflation that meets the target are more likely to occur earlier."

Economic Downturn: Limited Risks

While acknowledging the possibility of an economic downturn, Goldman Sachs also dismisses concerns in the market about a recession in the US economy, stating that the risks are not significant.

"The median market forecast shows a probability of around 50% for an economic downturn in the future, which is only slightly lower than the 65% at the end of 2022 and much higher than our own forecast of 15%." Goldman Sachs stated that the bank has four main reasons for being optimistic about economic growth: real income growth, the lag of tightening policies, the recovery of the manufacturing sector, and interest rate cuts by central banks.

Firstly, in an environment of low inflation and a strong labor market, disposable income in developed markets will significantly increase:

Although we expect real income growth in the United States to slow from 4% in 2023 to 2.75% in 2024, this should still be sufficient to support consumption and GDP growth of at least 2%. Meanwhile, as the impact of the Russian gas shock recedes, real income growth in the Eurozone and the UK will accelerate significantly, reaching around 2% by the end of 2024.

Secondly, although restrictive policies may drag down economic growth, the "biggest drag" is already behind us:

The maximum impact of monetary tightening on GDP growth rate (rather than level) occurs in a short and reasonably predictable lag period of about two quarters. Therefore, we expect that even considering the recent rise in long-term interest rates, the drag on the economy from tightening financial conditions in 2024 will be smaller than in 2023.

Furthermore, manufacturing activity will recover from its slump in 2023:

This year's weakness in industrial activity reflects a range of unusual adverse factors, including the normalization of spending patterns, a trough in gas-intensive European production, and a stabilization of the inventory-to-GDP ratio. Most of these adverse factors will fade this year, leading to a recovery in manufacturing from its low level towards the trend direction.

Lastly, Goldman Sachs believes that central banks will also strive to prevent a recession and will cut interest rates if growth prospects deteriorate:

Several emerging market countries that raised interest rates earlier have begun to lower policy rates from highly restrictive levels and may continue to steadily cut rates. We believe that there is limited room for developed economies to relax monetary policy ahead, but we believe that developed economy central banks will not waste time in turning to rate cuts if growth prospects deteriorate.

In fact, our analysis of past rate hike cycles confirms that when inflation normalizes below 3%, the likelihood of major central banks cutting rates to address downside growth risks is twice as high as when inflation is above 5%. This is an important insurance measure to prevent economic recession.

Interest Rate Cuts: Second Half of 2024

Goldman Sachs believes that although the threshold for rate cuts is low next year and some emerging market central banks have already started cutting rates, developed markets will not cut rates before the second half of next year unless economic growth is weaker than expected.

Our baseline economic forecast shows that inflation will still be slightly above target in 2024, the unemployment rate will remain below long-term levels, and GDP will grow at roughly trend speed.

Therefore, although we predict that central banks in major developed countries (except Japan) have completed rate hikes, our baseline forecast indicates that they have little motivation to cut rates in the short term. We also expect that developed countries will not cut rates before the second half of 2024 unless economic growth turns out to be weaker than expected. In developed markets, Goldman Sachs predicts that the European Central Bank, the Bank of England, and the Bank of Canada may start cutting interest rates earlier. This is due to the progress of inflation and weaker growth prospects in these regions, as well as the reaction function that the Bank of Canada values more.

In contrast, the strong economic growth in the United States will reduce the urgency of interest rate cuts. Goldman Sachs believes that the first interest rate cut will be postponed to the fourth quarter of 2024.

It is worth noting that Goldman Sachs believes that when policy interest rates eventually stabilize, central banks around the world are likely to keep interest rates above the long-term sustainable levels currently expected:

"We have raised our long-term policy interest rate forecasts for major economies by 50 basis points, with the United States at 3.5-3.75%, the eurozone at 2.5%, the United Kingdom at 3%, Canada and Australia at 3.5%, and other economies will also raise interest rates."

Goldman Sachs explains that an important driving factor for this view is the ambiguity of the concept of "neutral interest rate":

"The neutral interest rate is a concept that is not very clear, and changes in financial conditions are more useful in determining the appropriate policy stance. As the labor market rebalances, economic growth approaches potential levels, and inflation normalizes to target levels, many central banks will consider the reasons for further easing of monetary policy to be relatively weak, especially in a top-down situation.

If it is proven that the economy has resilience when the policy interest rate is at a higher level, some central banks may re-evaluate their estimates of long-term interest rates and conclude that the downward adjustment of the post-2008 cycle was excessive."

As for Japan, which is different from other developed economies, Goldman Sachs believes that the Bank of Japan will start to exit YCC in April 2024, first turning to tightening, and further raising the 10-year benchmark interest rate after potentially stronger spring wage negotiations, until officially abandoning loose policies in October 2024.

Outlook: Uncertainty and Higher Interest Rates

Although Goldman Sachs is generally optimistic about the basic expectations for 2024, data volatility remains high, so the bank's economists believe that the overall economic outlook still faces risks higher than normal levels.

"The most important thing is that the risks surrounding our policy interest rate forecasts are clearly biased downward. Although some central banks may raise interest rates again in the coming months if inflation unexpectedly rises, the continued progress in inflation limits the risk of central banks further tightening policy.

At the same time, as inflation continues to fall back to target levels, the barriers to interest rate cuts may decrease, indicating that the risks surrounding our policy interest rate forecasts are asymmetrically biased towards interest rate cuts, especially in the longer term."

In particular, as interest rates are expected to remain at higher levels in the long term, this may expose the "vulnerable areas" of the United States:

"The channels for small businesses to obtain financing, the continued pressure on credit supply from small banks, or the sluggishness of mortgage loans, housing, and commercial real estate activities—although we expect these to not threaten the overall economic outlook.

The public debt situation is also increasingly worrying, but we believe that the market will remain patient unless next year's US elections bring new unfunded fiscal expansion." Goldman Sachs also mentioned that there are downside risks to global growth:

The first risk is the continued unexpected decline in global manufacturing company surveys. This increases the possibility that our expected improvement in manufacturing activity may be delayed, especially if higher interest rates lead companies to normalize inventory levels (relative to sales) to below 2019 levels, or if still high levels of commodity demand (especially in the United States) return to long-term trends earlier than expected.

The second downside risk comes from geopolitical concerns. In particular, the escalation of the Middle East war has disrupted trade through the Strait of Hormuz, which could lead to a significant increase in oil and gas prices, potentially reducing global net growth.

Bullish on the US dollar and diversified assets

Compared to other economies, Goldman Sachs believes that the United States appears to be more resilient, with greater risks in places like the Eurozone. Therefore, they also tend to predict that the US dollar will continue to strengthen:

Although we forecast a good growth outlook for the Eurozone in 2024, recent poor macro performance may indicate that the impact of energy supply shocks will be greater. If global interest rates remain high, another medium-term risk we are concerned about is the impact of rising nominal interest rates on the sustainability of Italian debt.

While we expect widespread developed and emerging market economies to avoid recession next year, the reasons for the strong performance of the US economy seem more compelling. Although market pricing may include more optimistic growth views than consensus forecasts, we believe that the fact that our GDP growth forecast for the United States is further above consensus than for Europe still contains real information.

In addition to our expectation of generally declining inflation, this background weakens the possibility of a significant weakening of the US dollar, although the end of the Federal Reserve interest rate cycle and a favorable global growth outlook often put pressure on the US dollar.

If other major economies do not experience substantial upside surprises, it is difficult to have much confidence in a long-term weakening of the US dollar. Therefore, we believe that the risk tends to be a continued strengthening of the US dollar.

In this context, Goldman Sachs believes that the cash return rate in 2024 will still be high, but the performance of other asset classes such as bonds will (moderately) exceed expectations.

Each asset class should be able to hedge against a key tail risk: if the risk of recession increases, the performance of bonds should be stronger; strong global economic growth and geopolitical turmoil pose upward pressure on oil prices; if central bank interest rate cuts occur earlier than expected, the performance of the stock market may be better than expected.

Although front-end yields still appear attractive, we believe that this situation implies that a more balanced asset exposure may replace the focus on cash dominated in 2023, including playing a more important role in investment portfolios. It makes sense for investors who believe that the possibility of an economic recession and interest rate cuts is higher to lean more towards long-term investments and stay away from risk assets.