The global economy fell off a cliff late last year as the credit crunch brought economic activity to a standstill, and most major economies appear to have contracted at a sharp rate in the first quarter as well. Although recent data suggest that the bottom has probably not been reached yet, rates of decline may be starting to slow. Eventually, however, the global economy will begin to recover. Will major economies rise from the ashes at the same time and pace, or will certain economies lead others?
In our view, China will probably be the first major economy out of the gate. China did not have many of the problems that plagued other major economies, and Chinese policymakers were quick to enact expansionary macroeconomic policies. The U.S. economy faces some formidable challenges, but it should be one of the first economies to post positive growth numbers again due to the unprecedented stimulus that has been applied. The U.K. economy, which in many respects resembles its American counterpart, should start to turn the corner as well later this year. In contrast, the Euro-zone will likely lag the United States and Great Britain due to the tepid policy response to date in continental Europe. Japan should also be one of the last major economies to emerge from the current downturn.
Our views regarding near-term trajectories of the world’s major economies influence our foreign exchange rate forecasts. Specifically, we project that the U.S. dollar will strengthen versus most major currencies over the next few quarters as the United States shows signs of emerging from the downturn before most other major economies.