Image of a roof

Next year should bring some continuation of the U.S. dollar downward trend that began in October 2022 due to narrowing growth and interest rate differentials, as well as flows returning to non-U.S. markets (as they began to in 2023).

Despite the negative headlines, the global economy has grown 2.8% so far this year, in line with its 15-year average pace. Beneath the surface, however, a lot of divergence is on display – albeit not the divergence investors expected going into the year. The eurozone, UK, Canada and China ended up disappointing, while the U.S., Japan and emerging markets ex-China ended up surprising positively. In Europe, energy rationing did not occur, but neither did falling energy prices deliver an uplift, as consumers remained cautious and higher rates weighed on manufacturing. In China, the end of “zero COVID policy” did not prove disruptive, but still low confidence led to a subdued recovery in investing, hiring and spending despite normalized mobility levels.

In 2024, the key question for the global economy is: will this divergence persist, and if not, will it close in the positive or negative direction? Central to this question is consumer spending (Exhibit 1). Japanese and U.S. consumer goods spending has been robust and is now above pre-pandemic trends, but consumers in the eurozone, UK and China have been cautious, with spending still 6%, 11% and 20% below trend, respectively. The good news is this is where excess pandemic savings persist. There is hope for some modest reacceleration in Europe, as inflation continues to fall (boosting real incomes) and the sticker shock of 2022’s energy price spike fades. In China, consumers may remain cautious for a bit longer given a weak housing market, but policy makers are now in pro-growth mode, providing a floor to growth at this year’s 5% pace. Meanwhile, like the U.S., growth in Japan and emerging markets ex-China should downshift from this year’s pace given used up savings. This should leave global growth less divergent, albeit a bit slower than its long-run average. A heavy calendar of elections next year may be consequential, especially the one in Taiwan (given geopolitical tensions with China) and India (given the positive reform momentum under the Modi government). 

Central bank action has been more uniform since 2022 (with notable exceptions of easy policy in Japan and China), as central banks hiked rates aggressively to combat globally elevated inflation. Next year, more divergence may creep in: as the year ends, U.S. and Eurozone core inflation has already retraced about half of its pandemic surge, the UK only a third, and Japan’s is still hovering at its peak (Exhibit 2). The key to these differences is wages, with sticky wage growth in Europe and (finally) accelerating wages in Japan. This gives European central banks less breathing room to start cutting rates as soon or as quickly as the Fed and pressures the Bank of Japan to finally get going on exiting negative rates. The lone exception to stimulative policy should remain China, given below-target inflation and modest growth. 

Next year should bring some continuation of the U.S. dollar downward trend that began in October 2022 due to narrowing growth and interest rate differentials, as well as flows returning to non-U.S. markets (as they began to in 2023). The risk to this thesis is U.S. recession fears returning, which would dampen investor sentiment again. Stronger international currencies should provide a relief for central bankers’ fights against inflation and for U.S. dollar-based investors’ international returns from this year’s very small currency drag.

09zz231512221702