How geopolitics might crash a 2024 economic soft landing

The economic soft landing for the US-led developed world, ridiculed as an unrealistic hope by many over the past year, looks more likely than ever as 2023 comes to a close. But looking forward to 2024, geopolitics looms as a potential spoiler. Let us count the ways.

For the moment, Russia's war on Ukraine seems to be at a stalemate, the Israel-Hamas conflict remains mostly localised (though that may soon change) and the temperature of the US-China rivalry is cooling somewhat after a face-to-face between Joe Biden and Xi Jinping. But any or all of these geopolitical dynamics could change for the worse next year, affecting swathes of the global economy.

Even within the field of economics, 2024 brings with it new risk. Though largely successful in driving down pandemic-induced inflation, the full impact of aggressive monetary tightening campaigns may not yet be known. It's arguable that, if global policymakers don't ease decisively, the long-awaited soft landing could still come a cropper.

Adding to uncertainties next year are a welter of elections in more than 50 economies, shaping the incentives of policymakers and their political opponents. One in particular could radically affect geopolitics and global economics alike. As the New Year approaches with global stocks not far from all-time highs and the battle against inflation all but won, it's worth looking at the potential trouble 2024 could bring.

Indeed, it's not impossible that things start coming apart in January. American assistance to Ukraine is running out as Republicans demand new restrictions on US asylum seekers and harsher measures on migrants as their price. The European Union has its own far-right opponent of Ukraine aid—President Viktor Orban of Hungary—who has made plain his warm relations with Vladimir Putin.

A collapse of Ukrainian lines, were it to happen, would impose a new shock that could undermine global confidence. The boost it would give Russia would also have unpredictable consequences, perhaps tempting Putin to test Washington while US attention is focused on aiding Israel in its war.

Almost three months of war in the Middle East has killed more than 20,000 Palestinians, according to the Hamas-run Gaza health ministry, while Israeli officials said 1,200 Israelis were killed in the 7 October attack that triggered the conflict. But it has yet to spur a full-scale regional war.

That could very well change in the new year. Some members of Israel's government favor expanding the war to Lebanon and Iran-backed Hezbollah, which has been exchanging fire with Israeli forces in the north. Such a move would likely trigger full involvement of the well-armed Iranian proxy, and perhaps Iran itself, Gavekal Research analysts argued in a Dec. 18 note.

"In the event of an Israeli offensive, Tehran would be compelled to provide greater and more visible support to Hezbollah than it has given Hamas, or it would risk losing credibility among its other proxies," Tom Holland and Yanmei Xie of Gavekal wrote.

Attacks on Red Sea shipping by Yemen-based Houthi rebels aligned with Iran, the involvement of US Navy ships in repelling armed drones and a recent killing of an Iranian military official in Syria may also add fuel to the fire. Houthi attacks could theoretically close off the Bab El Mandab Strait—the strategic chokepoint at the Red Sea's southern end—imposing a major economic cost.

The threat comes as the US mulls a "heavy" response against the group. The Pentagon has been trying to reassure shipping companies that a multinational force is making it safe to sail through the Red Sea and Suez Canal, but half of the container-ship fleet that regularly transits both is avoiding the route, according to new industry data.

"The West will have to bear the cost of disruption to the 10% or so of world trade that passes through the Bab on its way to or from Suez," Holland and Xie wrote. The danger is "a large handful of sand in the wheels of global trade—which is bad news for growth and for many markets."

Further to the east, presidential elections loom in Taiwan, a 13 January vote in which Beijing has taken enormous interest. The mainland has made clear it opposes Vice President Lai Ching-te, whose party favours de-facto independence. Provocative actions by either side in the event of a Lai victory could see tensions rise in another vital area of global trade.

To make matters worse, these three geopolitical dynamics could theoretically feed off of each other. A Russian victory over Ukraine at the same time Iranian proxies close down crucial European-Asian maritime trade could in turn embolden Xi with regard to Taipei.

But all of that is the worst-case scenario.

If geopolitical tensions don't end up derailing the global economy's current trajectory, the big economic question for 2024 will instead be a less dire one: whether interest rates return to pre-Covid levels.

As 2023 progressed, an increasing number of economists cautioned that, once the inflation surge abated, borrowing costs would probably settle at a higher level than those before the pandemic. They gave a number of reasons.

First, the reshaping of global supply chains to make them more secure would likely make them more costly. Second, the green energy transition may push up power costs before renewable sources can make up for what fossil fuels provided. Also, concerns about lingering high or variable inflation could make bond buyers demand higher premiums.

But not everybody buys that argument. For one thing, China has been ploughing massive amounts into its manufacturing industries, at home and abroad, and global excess capacity could dampen goods prices round the world. Longer retirements may boost the savings to pay for them—weighing down on longer-term interest rates.

As inflation (presumably) keeps coming down and central banks (presumably) launch their rate-cut cycles, greater clarity ought to develop on where the end-point will be for borrowing costs.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.