daniel chigunweIt’s the year of the soft landing—and of interest-rate cuts that will support growth and markets around the world. So runs the upbeat conventional wisdom about the global economy in 2024.
What could possibly go wrong? After years marked by war, pandemic and bank collapse, it hardly needs saying: a lot. That includes — but is not limited to — the following.
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After more than three months, Israel’s war in Gaza has brought the region to the brink of a wider conflict with the potential to choke off oil flows, take a chunk out of global growth, and push inflation higher again. That kind of energy-supply disruption hasn’t happened yet, and markets are betting it won’t. But the risk is rising.
Tensions have escalated in the Red Sea since the US and UK launched airstrikes in Yemen, a response to weeks of attacks by Houthi militants on vessels in a key gateway for global commerce. Daily exchanges of fire along the Israel-Lebanon border, and the assassination of a Hamas leader in Beirut, risk drawing Hezbollah — and consequently Iran — deeper into the fighting. Iraq and Syria increasingly look like flashpoints too.
Our base case remains that a direct Iran-Israel war is unlikely. If that extreme scenario did materialize then one-fifth of global crude supply, as well as important trade routes, could be at risk.
Crude prices could surge to US$150 per barrel, shaving about 1 percentage point off global GDP and adding 1.2 percentage points to global inflation.
That would be bad news for the Federal Reserve, and for investors betting on an early and aggressive pivot to rate cuts.
In the 1970s, Fed chair Arthur Burns pivoted too early. The result was a resurgence of inflation, requiring extreme measures from his successor Paul Volcker to bring prices under control.
There’s two ways 2024 could see a repeat, albeit in miniature. One involves a supply shock — a real possibility if an escalating Middle East conflict hits oil prices and shipping lanes. The other would stem from looser financial conditions – with the five-year Treasury yield down more than a percentage point from its October high.
Plug a one-percentage-point drop in yields into Bloomberg Economics’ model of the US economy, and it nudges inflation in the year ahead up by half a percentage point, bringing it closer to 3 percent than the 2 percent target. If that happens, the Fed might have to pause the pivot—frustrating market expectations of an easier policy stance.
Our new natural language processing model for capturing Fed speaker sentiment shows officials have left themselves a lot of room for manoeuvre. The model — trained on 59 000 news headlines on Fed speeches and press conferences — shows officials trending dovish but still a long way from committing to cuts.— Bloomberg.
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