• Risks of less rotation in July surveys...
• … but indicators still point to solid overall global growth
• Balancing growth and inflation risk opens door for DM easing
• Next week: Fed on hold; BoJ hikes; US job gains slow

Last week, we described the global expansion as moving through an orderly transition with anticipated rotations toward manufacturing and away from the US taking hold amidst a moderation in global GDP growth to a trend-like pace. Incoming July survey readings challenge our views on both of these rotations. The latest downshift in manufacturing surveys is accompanied by positive readings from the service sector. Disappointment in the Euro area and China, meanwhile, come together with positive surprises from the US and EM ex. China. Given our perspective that balance across regions and sectors promotes resilience, this news shifts growth risks downward. However, the shift is not substantial enough to point to a meaningful threat to the expansion. We judge the US and global expansion as still standing on firm ground at midyear and see risks to our second-half global forecast for 2.1%ar global GDP growth as still modestly skewed to the upside.

A second consecutive disappointing DM manufacturing PMI aligns with weak July national surveys to question whether a mid-year recovery in DM factory output will prove to be a flash in the pan (Figure 1). A notable sharp loss in momentum in the PMI new orders-inventory ratio last month challenges our view that solid gains in retail spending and capex will provide ongoing support for the

manufacturing recovery. We see two reasons to be cautious in interpreting the manufacturing PMI. First, the survey has consistently underestimated output gains in recent years, delivering sporadic downbeat signals that were reversed. Second, we see fundamental supports for both consumer and business spending and both are tracking solid gains around midyear. More broadly, this month’s manufacturing survey contrasts with an upside surprise in services. The all-industry survey remained stable in July as the services survey moved higher in both the US and Japan (Figure 2). Combined with solid labor market indicators this points to sustained service sector and GDP growth.

More concerning are the signals on Europe, which continues to show a lackluster recovery from last year’s stall. Our forecast that Western Europe will awake from last year’s stall is consistent with 1H24 with regional GDP tracking a 1.5%ar 1H24 GDP gain. But the Euro area all-industry PMI stepped down for a second consecutive month. With this decline mirrored in the Ifo and Insee surveys we have lowered our sights on Euro area growth this quarter.

Recent developments point to a more balanced alignment of growth and inflation risk opening the door for central banks to lower policy rates. The Fed is unlikely, however, to ease at next week’s meeting. While refraining to provide clear guidance on the timing and magnitude of the easing cycle, it should reinforce the case for a September easing by emphasizing the rebalancing of risk and its growing confidence that inflation is on the right path.

If we are right, the US growth and inflation performance will keep the Fed balancing growth and inflation risks for some time to come, an outcome consistent with a shallow once-a-quarter easing cycle. In assessing risk, much recent discussion has revolved around the past year’s 0.5%-pt rise in the unemployment rate, which could point to greater downward pressure on both growth and inflation. Indeed, the near breach of the Sahm rule was cited this week by former FRBNY president Dudley as a reason why the Fed should ease next week.  

The Sahm rule was designed as a descriptive tool—one that reliably signals a rise in the unemployment consistent with the start of a recession. It is possible that we breach this rule in next week’s job report. If so, we should brace for a dramatic shift in 2H24 labor market conditions. In every episode before the pandemic that the Sahm rule has been triggered, the US unemployment rate has risen by a minimum 0.8%-pt in the following six months.  

We have argued that the business cycle signal of a rising unemployment rate has been weakened in recent years by measurement problems related to population sampling. In this regard, the underlying behavioral shift that the rule captures—a significant shift by firms to shed labor—is not evident in other measures of job loss. This break is evident in the continued stability of the insured unemployment rate through July and will likely be reinforced by the continued stability in layoff rates in next week’s JOLTS report. We do expect a slowdown in employment gains in next week’s payroll report (150k), but interpreting this outcome will likely be complicated by possible hurricane effects in the sample week.

We put more weight on the risk that the rise in the unemployment rate reflects a boost to labor supply that could moderate wage pressures. Next week’s employment cost index will provide important new information on this front. Our forecast is for a moderation in the ECI, though wage inflation would still have an elevated 4.2% over year rate (Figure 3).

Synchronized easing on the way

The coming year is forecasted to deliver the most synchronized monetary easing cycle in history outside of a recession. In tracking the start of this global easing cycle, it is important to not overstate the importance of the Fed and ECB in leading the way. But it is a mistake to confuse synchronization with coordinated action. Domestic conditions are almost always the key to policy setting and we show in a special report this week that the output gap and core inflation explain most of the cross-country variation in policy rates—both now and in our forecasts for the year ahead (Figure 4).

The synchronization of policy easing owes to the fact that much of the world is seeing an unwinding of supply shocks delivering falling inflation. Still, the results of our report suggest that the wide variation in starting conditions and projected changes will be important factors of differentiation in rate outturns. We see less scope of easing across most of Asia and much of CEE and more scope across Latin America. Beyond macro conditions, the EM will also be sensitive to a range of other factors. For example, leverage concerns have kept the BoK more cautious, while political risks play a role in our call for the BCB to remain on hold.

Another hike on deck for the BoJ

Next week should deliver the BoJ’s second hike this year after moving rates out of negative territory in March. We expect a 15bp hike to 0.25% along with an announcement of the future path of the BoJ’s JGB purchases. The move comes against a backdrop of rising confidence in reaching the BoJ’s inflation goal, reinforced by firming wage growth and signs of a pickup in consumer spending. Indeed, wage momentum and the recovery in domestic demand are now posing some upside risks to future inflation. Governor Ueda likely will likely temper his remarks, reiterating a gradual path for rates back to neutral, but we will watch for guidance regarding the terminal rate and the time frame to get to there.

China: growing pressure for policy support

Last quarter’s sharp growth deceleration has raised pressure for increased policy support in China. Despite weak consumer spending and a contracting real estate sector, government bond issuance has lagged with only 38% of the full-year quota issued in 1H24. We expect GDP growth to return to a trend-like 4.5%ar in 2H24 assuming policy remains modestly accommodative and special bond issuance accelerates in line with the targets approved at the March National People’s Congress. Alongside this week’s earlier-than-expected policy rate cuts, the authorities announced a program to support equipment upgrades for corporates and consumer subsidies for car and home appliance trade-ins. We await further policy signals from this month’s Politburo meeting but do not expect much in the way of additional stimulus.

Korea down, Taiwan up in 2Q24

While robust tech demand has supported growth across North Asia’s bellwethers, domestic demand performance has been varied across economies. Korea’s exports held up in 2Q but falling domestic demand led to a 0.9%ar GDP contraction after 1Q’s outsized gain. We look for a recovery in consumer spending along with robust export gains to drive a stronger 3Q rebound to 4%ar and for the annual GDP growth outturn to exceed the Bank of Korea’s forecast (2.5%). Meanwhile, Taiwan’s June export orders took a step down after its recent rapid gains but IP growth remains firm and the strength in external demand is feeding into the domestic economy, evident in surging capital goods imports and respectable gains in retail sales. We look for solid 4.5%ar growth in next week’s advanced 2Q GDP report.

India budget remains on consolidation path

India has doubled down on fiscal consolidation in its first budget since the elections, targeting a fiscal deficit of 4.9% of GDP—lower than the interim target of 5.1% and down from 5.6% of GDP last year. Conservative tax assumptions raise the risk that the deficit could end up being even lower. A large annual dividend from the RBI is helping to cut the deficit without much pain and the implied modest tightening in the fiscal stance (to the tune of 0.3% of GDP) should keep GDP growth strong. Growth continues to be driven by public capex and service exports but the budget’s focus on job creation is encouraging and could help boost consumption and thus broaden the base of growth.

CEE easing shifts to lower gear

As a Western Europe easing cycle begins there is only modest space for easing in Central Europe. After delivering a 15^th consecutive rate cut this week, Hungary’s NBH signaled limited space for further cuts amid a stall in the disinflation process. In Czechia, inflation is at target, but the board is cautious about aggressive easing due to upside inflation risks. Growth disappointments could deliver more easing and regional manufacturing is facing problems similar to the Euro area’s.  With the exception of Hungary our growth nowcasters point to downside risk to our 2Q GDP forecasts, although we still see scope for EU fiscal transfers to boost capex in the region.  

LatAm: Home court rules

In Brazil inflation has moved close to the BCB’s target, but currency weakness and rising inflation expectations, related to political uncertainty, have pushed markets to price in rate hikes this year. We think the BCB’s restrictive stance gives it some leeway and we see rates remaining on hold. Meanwhile in Mexico, upside inflation surprises in June and July are challenging Banxico’s earlier dovish pivot. We see the August rate decision as a close call but on balance still expect a 25bp cut. With core inflation well-behaved and growth softening, we look for a further cut in December and intermittent easing through 2025. On top of the recent surge in raw-food prices, further peso weakness around the US election remains a key risk to monitor. The central banks of Chile and Colombia meet next week, and we expect CBC to be on hold given the advanced stage of its easing cycle, while BanRep should continue cutting in 50bp steps.