Lull Before the Storm?

Downside risks to baseline global forecast just released by the IMF — weakness in China and Europe exacerbated by mounting political and social tensions.

For old-time forecasters like me, there is nothing like the International Monetary Fund’s regular update of its World Economic Outlook (WEO) — it has all the detail, analytics, supporting data, and internal consistency that any of us could ask for. Back in my Wall Street days when I led the forecasting team at Morgan Stanley, the WEO exercise was the gold standard that we all strived to emulate. It still is. But the high quality of the effort is no guarantee of the accuracy of the forecasts. As I sift through the latest update of the WEO just released by the IMF ahead of its annual Washington meetings, I have an uneasy feeling about the global economic prognosis for three reasons:

First, consistent with the hopes and dreams of frothy financial markets, the WEO expects a  $110 trillion (USD) global economy to be on a perfect glide path to the ultimate soft landing.  The forecast of 3.2% average world GDP growth over the next five years (2025-29) is virtually identical to the average pace recorded in the 43 years since 1980.   Such an outcome is always possible, of course, but the weight of history suggests otherwise. Soft landings are heavily dependent on the interplay between inflation and monetary policy.  The global soft landing of 2012-19, when world GDP growth held steady around 3.4% for eight years in a row, came at a time of relative tranquility on the inflation and policy interest  rate fronts.  The sticky residue of the post-Covid inflation shock of 2020-22, together with mounting protectionist threats,  provide no guarantee of such tranquility in the years ahead for inflation-targeting central banks.

Second, disparities in the mix of world output are starting to look problematic. That’s certainly the case for the advanced economies; over the five-year forecast period (2025-29), the latest IMF baseline expects US economic growth to average 2.1%, more than 60% faster than the anemic 1.3% pace expected for the Euro Area. A similar disparity is evident within the broad collection of emerging and developing economies: Chinese economic growth is expected to slow to just 3.7% over the next five years, far short of the 8.9% pace from 1980 to 2024; at the same time, growth in the developing world ex China is expected pick-up to 4.3%, more than 15% faster than the pace in China — a real stretch in a China-dependent developing world. In short, sharply reduced growth contributions from both Europe and China, which collectively account for more than 35% of world output in 2024 (PPP basis), underscore the downside risks to IMF and consensus forecasts of a global soft landing.

My third concern is admittedly more of a wildcard — the potential for social and political repercussions of a world in conflict.  With a Substack entitled “Conflict,” you would probably expect me to say that. But it would certainly come as a major surprise to the soft-landing bet currently being made in world financial markets. Yet denial of such a possibility runs deep.  Interestingly enough, that point was underscored in the IMF’s latest WEO, which also explored the topic of social unrest.  It did so by drawing on academic research that attempts to use media reports to measure the portion of economies in the world that are experiencing major bouts of social unrest. An updated version of recent trends in this metric since 2018 is shown in the chart below.

As can be seen, through mid-2024, this gauge of global unrest is near its post-2018 low.  While shocking at first blush, especially in light of the widely held view that we are in the midst of unprecedented shocks not seen in a century, this observation is actually quite consistent with the general sense of blasé embedded in frothy financial markets — that despite all the hand wringing of worrywarts like me, fears over mounting social and political tensions are vastly overblown.

For what it’s worth, my advice is don’t count on this complacency to continue.  With wars raging in Ukraine and the Middle East and with the legacy of January 6, 2021 hanging over a polarized, nervous US electorate that is about to head to the polls, I wouldn't be surprised to see a sharp rise in this gauge of unrest in the months ahead.  If that occurs, the academic research from which this chart has been drawn stresses the negative implications for economic performance — yet another reason to underscore downside risks to the widely accepted global soft-landing prognosis.

In the interest of full disclosure, I have long been a skeptic of the fabled soft landing.  This goes back to my Wall Street days and my periodic warnings of the perils of global imbalances, major asset bubbles, debt traps, and fragile economic recoveries.  While most of my warnings were close to the mark, some didn't always pan out.  A full confession can be found in “My Worst Forecasting Mistake,” describing my embarrassing wrong-way call for a double-dip recession in mid-2021. Alas, predicting the future is hardly a cake walk.

As I look back on all these decades of forecasting, three key lessons come to mind: First, don’t dismiss the ever-present perils of the business cycle.  Back in grad school, I read a collection of articles edited by the eminent economist, Martin Bronfenbrenner,  assembled under the provocative title of “Is the Business Cycle Obsolete?”  Released at the end of the 1960s, when seemingly nothing could stop the high-performance US economy, the publication of this book was quickly followed by a succession of increasingly severe business cycles — first, a mild downturn (1970), then a wrenching recession (1973-75), and finally a monstrous downturn (1981-82).  I used to keep a copy of the Bronfenbrenner book on my shelf as a reminder of the ever-present pitfalls of the business cycle, but it was stolen by a disgruntled Morgan Stanley bond trader in the 1980s.

Second, my approach to business cycle forecasting  has long relied on the “stall-speed” construct.  For the global economy, that means a zone of vulnerability in the 2.5% to 3.0% range for world GDP growth; when global growth slows toward the upper end of that band, I have invariably sounded the alarm. When global growth falls through the lower end of that band, global recession invariably follows. The current 3.2% five-year forecast of the IMF’s WEO is only slightly above the upper bound of the stall-speed zone. 

Third, is the shock — impossible to call but well worth worrying about when the world falls into the stall speed zone.  If the global economy is hit by a shock when world GDP growth is in the 2.5% to 3.0% range, it lacks the cushion of resilience otherwise required to withstand the impacts of such a blow.  Over the years, I have found that recessions reflect the combination of vulnerability and the unexpected blow. That worked reasonably well in my global recession calls of the early 1990s, the early-  and mid-2000s, and then again just ahead of the Covid shock of 2020.

The IMF’s latest World Economic Outlook comes a key inflection point for the global economy. Financial markets are giddy with hopes of another soft landing. And apparently with good reason — the growth forecast appears constructive and central bankers are basking in the warm glow of dispelling the most serious inflation shock since the 1980s. Beneath the surface, however, there are some disquieting signs of emerging imbalances, especially as the China slowdown now reinforces the malaise in Europe. The biggest risk, in my view, is the complacency over social and political unrest, especially at a time of mounting domestic and geopolitical turmoil.  The legacy of Martin Bronfenbrenner makes we wonder if this is merely the lull before the storm.