Global growth is expected to expand at a subdued 3% annual pace between 2024 and 2026, when measured on a purchasing power parity basis. That is more than a half percentage point below the average of the 2010s.

China is doing a bit better than it was, but is no longer a tailwind for the global economy. India continues to post solid if not spectacular gains, despite much younger demographics than other parts of the world. Hurdles are legislative bureaucracy and an inadequate energy grid.

Emerging Asia and parts of developed Asia are doing considerably better. They are reaping the benefits of shifting supply chains and the frenzy to scale generative artificial intelligence (GenAI) modeling. Taiwan and South Korea are both major chip producers and lower end chip fabrication is spreading to emerging economies in the region. Threats to curb chip imports would take wind from their sails.

Headwinds

Obstacles to stronger growth include:

• The cumulative effect of inflation on price levels and the bite of earlier rate hikes;
• Central banks’ fear of cutting prematurely and losing ground gained on inflation;
• The end of COVID-era fiscal stimulus and mounting sovereign debt levels;
• Escalating geopolitical tensions and protectionism;
• Heighted levels of uncertainty, which constrain investment; and
• Aging demographics, which are adding to fiscal challenges and limiting the supply of labor.

The result is a more fragmented global economy, which is more susceptible to supply shocks. That raises inflation risks.

The only major offset is the promise of productivity gains associated with GenAI. The International Monetary Fund (IMF) has developed an GenAI preparedness index for 174 countries. Many of the wealthiest and largest economies top that list, including the US. Most developing economies are closer to the bottom. Many lack the talent, energy and financial resources necessary to leverage GenAI.

Those who can implement GenAI want their own sovereign models to guard against more nefarious uses of the technology; cyber-attacks are soaring. Not surprisingly, governments are rapidly becoming some of the most aggressive investors in GenAI models.

Inflation appears to have peaked across much of the world, but service sector inflation is looking sticky. That has slowed the glide path on rate cuts in developed and developing economies. A strong dollar is further complicating matters as it could buoy prices abroad.

The exception is the US, where inflation has cooled. The Fed’s decision to delay rate cuts appears to be paying off. The strong dollar benefits the US by compounding the downward pressure on prices we have seen due to discounting.

Short-term interest rates have either peaked or moved beyond their peak for most countries. Exceptions are Japan, Türkiye, Russia and parts of Central and Eastern Europe, where rates are likely to rise or remain higher for longer.

The discussion on immigration’s role regarding inflation was nuanced. The short-term effects of extremely large inflows, like we saw in Canada in recent years, added to inflation. Wealthy newcomers bid up shelter costs and rents.

The situation is less dramatic elsewhere. Much of the rise in home values and rents in the US was due to acute shortages, the movement of wealthy households from former hot spots on the coast to boom towns in the Sunbelt. An influx of immigration added to those pressures in some local markets, but has already begun to ease. A surge in immigration only exacerbated those pressures in local markets.

Conversely, immigration played a key role in boosting labor supply and easing labor shortages. Over 70% of the growth in the civilian labor force in the US since February 2020 was due to a rise in foreign-born workers. They often filled jobs that were long open in sectors many native-born workers would not accept.

The industries most dependent on foreign-born workers in the US are agriculture, leisure and hospitality, other low-wage service sector jobs and construction. That has helped to slow service sector inflation in the US, even as it persisted in other countries.

Rate cuts across major economies

The Bank of Canada was the first among the Group of 7 - Canada, France, Germany, Italy, Japan, the UK and US - to cut rates in June and is poised to cut again in July. Economic growth is expected to remain essentially unchanged in 2024 and rebound on the heels of lower rates in 2025 and 2026. Recent curbs to immigration are expected to limit the upside on growth.

The Federal Reserve is expected to join the party and cut before year-end. Recent inflation data has cooled more than expected, while concern about weaker growth late in the year has intensified. Chairman Jay Powell all but admitted as much in his recent testimony to Congress. “Reducing policy restraint too late or too little could unduly weaken economic activity and employment,” he said.

The European Central Bank did what was characterized as a “hawkish” cut in June but is expected to remain on hold until at least September. A recovery earlier in the year appears to have fizzled, while service sector inflation has proven sticky. The manufacturing recovery has lost steam which is taking a toll on Germany, the region’s largest economy. France is doing better than Germany but uncertainty triggered by recent elections is a headwind. Growth in the region is expected to pick up a bit in 2025 and 2026.

The Bank of Japan hiked short-term rates for the first time in eight years in March and announced that it would curb the pace of its bond purchases starting in August. Another rate hike is expected this year, but not as soon as financial markets would like. In response, the yen depreciated sharply during the first half of the year. Efforts to stem those shifts with currency interventions failed. Wages rose at their fastest pace in 30 years in May but fell for the 26th consecutive month after adjusting for inflation.

Risks of a fiscal crisis

The largest central banks are raising their estimates of what they consider to be the non-inflationary or neutral policy rate. This higher terminal rate marks a return to the norms we saw prior to the global financial crisis. That means that central banks plan to stop cutting rates well short of where they were pre-pandemic, barring a major recession.

Higher rates will increase the cost of servicing government debt. Risks of fiscal crises abound.

A trifecta of events is fueling increases in deficits and debt:

1. Strong spending pressure due to aging demographics, defense spending and climate and industrial policies;
2. Political resistance to an increase in taxes; and
3. A reluctance to endure the pain associated with the fiscal adjustments necessary to bring budgets into balance.

Argentina is an outlier - yes, you read that correctly. The president has taken a chainsaw to the budget and triggered a deep recession to reduce deficits. However, the cuts are temporary and structural reforms are needed. The clock is ticking over how long the population will tolerate the losses they are enduring.

Concern about the debt situation in the US is greatest. The dollar remains the reserve currency of the global economy. Any threat to its status as a means of exchange would rapidly reverberate around the world. Neither political party has shown a willingness to reduce deficits via spending cuts and tax hikes. The last time we saw budget surpluses was during the boom of the 1990s; they were quickly squandered.