Global Economic Outlook & Strategy
CITI’S TAKE
The global outlook continues to be shaped by two competing factors. First, the conflict in Iran remains unresolved and the Strait of Hormuz is still largely closed. Oil prices have generally traded at or below $90/barrel in recent weeks, reflecting signals that President Trump continues to seek an exit from the conflict, but the associated uncertainties remain elevated. Second, despite headwinds from the conflict, the global economy continues to expand at a solid pace, which highlights our longstanding “resilience” theme. Global growth this year is running at a 2.6% pace, down a notch from last year but still solid given the magnitude of the shocks. All told, we see appreciable (two-sided) risks to our forecasts for both growth and inflation. These include the trajectory of oil prices, as well as simmering pressures in bond markets reflecting fiscal challenges in many countries.
Our resilience theme is reinforced by recent economic indicators—The global services PMI has rebounded after retreating at the onset of the Iran conflict and remains comfortably above 50. The manufacturing PMI has also posted solid readings, with support from surging AI spending as the global electronics PMI has risen sharply. In addition, the Citi Global Economic Surprise Index has bounced back through the summer, with firmer readings in the euro area. In contrast, US data have recently softened.
Central banks have pivoted toward tighter policy in response to the oil shock— Our policy rate forecasts for this year are now higher for 17 of 27 major central banks. In our view, the Fed and the BoJ face pivotal policy challenges. For the BoJ, we now see a hike in September and three more hikes next year, taking the policy rate to 2%, but market pressures could prompt a quicker pace of normalization. For the Fed, Chair Warsh has underscored his commitment to return inflation to 2%, but the lack of details on his strategy has left markets uneasy. We see Jackson Hole as a good venue for him to provide more clarity.
Our assessment of post-pandemic growth performance highlights divergent outcomes—Among DMs, the US has clearly outperformed, while Germany and the UK have underperformed. On a per-capita basis, Japan trails only the United States. For emerging Asia, we are struck by the rapid growth rates that these economies have achieved, but we also see evidence of a demographic divide taking hold in the region. In contrast, Latin America has produced softer growth outcomes that are far weaker than in emerging Asia, and Mexico’s per-capita GDP has essentially stagnated.
Global Resilience
Our global forecast continues to be shaped by two competing factors. First, the conflict in Iran remains unresolved, and the Strait of Hormuz is still largely closed. Even so, oil prices have generally run at or below $90/barrel in recent weeks (Figure 1), reflecting signals that President Trump continues to seek a path to exit the conflict. Even so, negotiations to date have been unsuccessful, and the risk of a further upsurge in oil prices remains significant.
Second, despite the pressures and uncertainties associated with the conflict, our longstanding “resilience” theme remains in play. Global growth this year looks to be running at 2.6%, down a notch from last year but still solid given the magnitude of the shock. This markdown is reflected in both our DM and EM growth aggregates, with DM growth projected to be 1.5% versus 1.8% last year and EM growth at 4.0% versus 4.3% last year.1As highlighted in Figure 2, these markdowns are spread broadly across a range of economies. Growth this year is seen to soften in Canada, the euro area, Japan, China, Brazil, and Chile. But some countries are successfully navigating the headwinds. Growth is expected to pick up significantly in Korea (on the back of strong semiconductor exports) and to a lesser extent in Mexico, Germany, Italy, and Sweden.
The global economy’s broad resilience is also seen in the recent performance of the Purchasing Managers Indexes (Figure 3). The global services PMI continues to rebound from its drop at the onset of the Iran conflict, and it remains comfortably above the 50 breakpoint between expansion and contraction.
The global manufacturing PMI has given back some ground over the past couple of months but remains strong relative to its lackluster readings over the past several years. This improved performance is driven in large measure by the burgeoning global AI sector. The electronics PMI has risen sharply in recent months—and key AI-producing economies including Taiwan, Japan, Korea, and the United States have seen particular gains over the past six months. Rapidly expanding AI investment (particularly in the United States) and correspondingly buoyant AI exports from some emerging Asian economies has been a powerful engine of global growth.
The Citi Global “Surprise” Index
The Citi Global “Surprise” Index, which compares the strength of incoming data to market expectations, tells a broadly complementary story (Figure 4). The index retreated as the Iran conflict erupted but bounced back through the summer and is currently performing well. That said, we have seen a notable shift in the country components. The index for the euro area has rebounded sharply. This has particularly been the case for the region’s “soft” data (e.g., PMIs and the German ZEW), but the “hard” data have shown increased perkiness as well (e.g., German factory orders and German real GDP growth).2 In tandem, the index for the United States has retreated, as highlighted by the surprisingly soft July employment and retail sales reports. Finally, readings for China remain weak. The country’s irrepressible export sector continues to drive growth, but the underlying private economy is soft.
Since the onset of the Iran conflict, our inflation forecasts have been marked up. We currently see global headline inflation running at 3.4%, up from 2.8% last year and roughly 75 bp higher than we expected before the conflict (Figure 5). Oil-importing countries such as the Philippines, Thailand, and Italy have been particularly hard hit. And our projections for core inflation are also higher, reflecting lingering pressures on supply chains (especially for petrochemicals, fertilizers, and aluminum) and other second-round effects. Specifically, core inflation projections have been raised a full percentage point for Brazil, and roughly ½ ppt for Korea, Thailand, Australia, the euro area, the US, and Japan
All told, we see appreciable (two-sided) risks to our forecasts for both growth and inflation. A key open question regards the trajectory of oil prices. With Brent currently trading around $90/barrel, scenarios in which the conflict escalates and oil prices move above $100/barrel would pose meaningful downside risks to growth and upside risks to inflation. In contrast, if the Strait reopens on a sustained basis, oil prices at or below $80/barrel are likely. Under such conditions, global growth would accelerate and inflation would retreat. We are also monitoring a range of other risks, including a souring of sentiment regarding the profitability of AI-related investments, as well as a further rise in longer-term interest rates in the face of the severe fiscal challenges in many countries.3
Drawing on this overview of global economic activity and inflation, the remainder of our report is divided into two sections. The first looks at the recent trajectory of central bank policy with a particular focus on the Federal Reserve and the Bank of Japan. The second section examines the global economy from a longer-term perspective. We evaluate the growth performance of major economies since the onset of the pandemic.