Markets have greeted the new year with optimism, none more so than in the US, where inflation has fallen faster, and growth remains more resilient than elsewhere.
Source: International Monetary Fund (IMF)
Forecasters have been surprised at the remarkable strength of the US economy, while growth in places like the UK, France and Germany remains lacklustre. The IMF said it expected the US to grow at 2.1% in 2024, an upgrade from the previous estimate of 1.5%. Other major advanced economies are expected to grow, but less quickly. The Euro area is expected to grow by 0.9%, as is Japan, and the UK is forecast to expand by 0.6%. Australia is projected to grow at 1.4%.
Evidence of US economic strength showed when a jobs report told of 353,000 new jobs in January and wages up 4.5%. A downside of the strong jobs numbers is that they are dashing hopes for early rate cuts from the Federal Reserve (Fed), now more likely in May rather than March. Most traders expect rates to end the year around 4.5%, implying a total of four cuts this calendar year. Before the jobs data, traders had expectations of up to six cuts.
Source: Bloomberg
America’s outperformance has come from several factors, including fiscal policy, resilient consumer spending, demographics and avoiding some of the energy problems that have beset others.
Part of the reason that economic growth has been strong is simple. The American government has continued to spend a lot of money. This is an election year after all!
Government expenditure as a share of overall output was around 35% in America in the years leading up to the pandemic, but in 2020 and 2021, it rose above 40% as the government responded to the coronavirus with about $5 trillion in relief and stimulus to people, businesses, institutions, and state and local governments. Locally, in Australia, government expenditure has averaged around 25% of GDP over the long term but hit a high of 32% in 2021 before dropping down to 27% in 2022.
Both states and households have only slowly spent down those savings, so the money has continued to trickle through the US economy. On top of that, government spending has remained elevated as the Biden administration has begun to make significant infrastructure and climate-related investments.
America’s deficit as a share of its GDP is larger than in many other advanced economies, and new spending is adding to the debt. Given that, strong growth today could come at a cost of higher interest bills down the road.
Proximity to geopolitical problems is also important. The US is one of the world’s largest producers of both energy and food, whereas European countries have been much more exposed to the aftershocks from Russia’s invasion of Ukraine in 2022, which pushed up oil and food prices.
More recently, tensions in the Red Sea that are disrupting shipping routes will have bigger spillover effects for Europe than for America. The disruptions have pushed up shipping prices and delayed deliveries of goods travelling to Europe from Asia.
Demographics also play a role.
When it comes to the absolute level of growth in the US versus advanced economies like the Euro area and Japan, America also has the benefit of a younger population. The median age in the United States is about 38 (very similar to Australia’s), whereas it is 47 in Germany and 49 in Japan. Young people help make an economy more dynamic. Younger adults work more, and pay more taxes, and families who are having children buy houses and spend more than retirees.
The Fed, the European Central Bank, the Bank of England (and sooner or later the Reserve Bank of Australia) are all nudging toward cutting interest rates as they try to avoid undermining growth. But central banks don’t want to lower rates too early and fail to fully stamp out inflation. They also want to avoid keeping them too high for too long, inflicting more pain than is necessary to keep price increases under control.
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