Quarterly Outlook 2023–2025: It All Hinges on Rates

Genevieve Signoret & Delia Paredes

(Hay una versión en español de este artículo aquí.)

We have built two forecast scenarios for the global economy and markets in the next eight quarters. What follows is the executive summary. For the full forecast report in PDF, click here or visit our Research page.

We believe that high U.S. long-term interest rates and uncertainty as to their future path are the biggest threat to the real economy and asset valuations in the next two years, and that the essential driver keeping long-term rates unexpectedly high for so long has been stronger-than-expected demand for consumer services and construction. We offer several hypotheses as to why demand for consumer services and for construction projects has been so resilient—not only in the United States but also in Mexico.

We see two alternative paths ahead for the United States and Mexico, a base case called Soft Landing and a pessimistic case called Roller Coaster.

In our base case, we assume that consumer service demand weakens this quarter and in 2024. Long-term interest rates peak in the next few months, allowing the economy to land softly before reaccelerating and allowing asset valuations, after a rocky period, to trend up. We assign a 65% subjective probability to Soft Landing.

In our pessimistic case, we assume that consumer service demand stays strong for much longer than in our base case. Long-term rates, therefore, rise higher still and well into next year, leading to a bear market and an eventual rate crash in anticipation of a 2025 recession. In Mexico, the 2025 recession is exacerbated by fiscal procyclicality. We assign a 35% subjective probability to Roller Coaster.

In both cases, in Mexico, the friendshoring narrative that we suspect has been supporting the Mexican peso fades some on electoral uncertainty, weakening rule of law, rising violence, concerns over Pemex, unreliable energy supplies, and the knowledge that 2025 will bring a fiscal adjustment.

In our base case, the peso ends 2023 at 17 pesos per dollar. The exchange rate weakens on electoral uncertainty prior to the 2024 presidential elections to 19.50 and then breaks with its usual pattern by failing to recover after the elections. In our pessimistic case, the exchange rate follows a similar path.

In both cases, the euro’s low against the dollar occurs this quarter, when it closes at US$ 1.07. Subsequently, the euro strengthens to US$ 1.10 and then stabilizes. The Japanese yen, by contrast, strengthens throughout the forecast period to end 2025 at 130 yen per dollar from a forecast end-2023 rate of 149.