International economy: Growth convergence, but central bank divergence

Entering 2024, we expected continued resilience in the global economy, but with less divergence beneath the surface. Last year, the U.S., Japan and pockets of emerging markets (EM) excluding China surprised positively, while the eurozone, UK, Canada and China ended up disappointing. Consumers are at the heart of the story. While U.S. and Japanese consumer goods spending has surpassed pre-pandemic trends, this has not been the case in the eurozone, UK and China, with spending still 6%, 10% and 19% below trend, respectively. In Europe, the energy price shock unleashed by the war in Ukraine dampened consumer confidence and spending, while China’s “Zero COVID Policy” and housing market slump left households cautious. Some of this divergence is now diminishing.

In the eurozone and UK, consumer confidence has been increasing consistently since October due to solid real income gains for households as inflation has finally decreased. This should power consumption moving forward. Additionally, the region is heavily exposed to manufacturing, which is now stabilizing, propelling Europe’s composite PMIs higher by 6 points since last year’s low. In China, the upturn in consumption should remain gradual given the continued weakness in the housing market. However, late last year’s pro-growth turn by Chinese policymakers has continued into this year. Fiscal policy continues to support infrastructure and advanced manufacturing – and has turned more forcefully toward housing in May – which should stabilize China’s growth rate at around 5%. Elsewhere in Asia, early signs of a global recovery in technology-related exports should benefit the big exporters, such as Korea and Taiwan. Lastly, India’s strong growth momentum should continue, as the election outcome implies continuity of economic reforms. Encouragingly, economic surprises have turned positive in the eurozone and emerging markets while those in the U.S. have turned negative (Exhibit 1). This suggests that we may have passed peak optimism about the U.S. economy and peak pessimism about the rest of the world. 

On the other hand, progress on disinflation has become more uneven, leading to divergent paths for central banks. Since December, year-over-year U.S. core inflation has moved down 30bps, compared to 80bps in the eurozone and 90bps in the UK. While expectations of Fed rate cuts have been pushed back and reduced, they have been pulled forward for the European Central Bank and the Bank of England – with European central banks now likely to cut rates first. For EM central banks, the delay in Fed cuts has led to slower or delayed rate-cutting cycles in response to currency pressure. Two important exceptions remain: China, continuing its stimulative monetary policy, and Japan, which finally embarked on a very gradual rate-hiking path.

Instead of decreasing, the U.S. rate differential with the rest of developed markets has increased again this year, by 16bps so far (Exhibit 2). As a result, the U.S. dollar has not depreciated as expected. Going forward, stabilizing interest rate differentials and narrowing growth differentials may put a lid on the dollar, keeping it strong (but not stronger) for longer. The U.S. election is a risk, as tariff discussions heat up again, especially for currencies of major trading partners. 

Supply chain relocations unlock opportunities for key beneficiaries 

Disruptive events, such as COVID-19, ongoing trade tensions between the U.S. and China and elevated geopolitical risks, have brought supply chains into focus. Companies are now seeking to diversify their production locations, while nations are increasingly favoring trade with allies. The shift is already evident, with China losing its status as the U.S.’s top trade partner since the implementation of tariffs in 2018. China represented 22% of U.S. imports just five years ago but now accounts for only 12%.

Other countries have stepped in to fill the gap. Some Asian countries, such as India, Vietnam and Taiwan, are poised to benefit from friendshoring due to their cost competitiveness, integration in global supply chains, favorable industrial and corporate policies and rising middle-income consumer bases. Within Latin America, a key beneficiary of nearshoring has been Mexico, thanks to its existing manufacturing hubs and low wages.

While nearshoring is gaining momentum, it will take time, as China remains an important trade partner for most countries and is uniquely positioned in key industries. Nevertheless, as we transition to a multipolar world, investors can participate in this trend by further diversifying their equity exposure with a focus on the potential beneficiaries.

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