What's in store for the global economy?
As the global economy emerges from the coronavirus pandemic, investors have three questions that matter for markets.
1. How quickly can the economy reopen and recover?
2. Will this cause a sustained rise in inflation?
3. How will monetary policy makers respond?
A shot in the arm for growth
Over the first quarter of 2021, economic growth expectations have risen, as investors grow more confident that the rollout of Covid-19 vaccines will allow the global economy to reopen. Vaccination programmes are progressing at varying rates in different countries, with supply and distribution constraints the most significant factor. To some degree, this is a question of a country’s willingness and ability to pay a premium for priority access to doses – explaining why vaccination rates in the world’s poorest countries remain virtually non-existent. However, decisions made by governments and regulators have had an impact too.
People vaccinated with their first dose as a percent of total population
Source: Datastream as at 5 March 2021.
A summer surge in inflation
The expected improvement in the global economy, with the resumption of services activity boosted by a catchup in deferred consumption, is likely to lead to several quarters of higher growth. This period of catch-up growth is also likely to lead to a period of higher inflation, as demand surges to overtake supply, supply-chain bottlenecks hit, and year-on-year comparisons flatter prices.
Just as the crash in inflation caused by the pandemic did not last forever, a post-pandemic spike could pass just as quickly. If households use higher savings to increase their consumption over several quarters, eventually those
savings will be exhausted, and year-on-year comparisons the following year would make GDP growth and the rate of inflation look lower in comparison.
The policy predicament
What does the prospect of higher inflation mean for monetary policy? As a rule of thumb, when inflation is above a central bank’s target, monetary policy is tightened. With today’s suite of monetary tools, that generally means higher interest rates, or a cut to the rate of asset purchases (known as Quantitative Easing) by the central bank.
Expectations of a sustained inflationary revival remain muted in Europe and Japan (where inflation had concerned central bankers by its absence prior to the pandemic), partly because the vaccine rollout is happening more slowly and fiscal policy is less accommodative. However, in the US, where unemployment was low before the pandemic and fiscal stimulus looks set to boost the post-pandemic rebound, expected rates of inflation and interest rates have risen in recent weeks.
While the outlook for growth points firmly to a recovery, and we anticipate inflation to rise in the near-term, the dynamics that would support a more sustained change in the inflationary environment are not well understood. With this in mind, we consider it prudent to acknowledge the risk that the period of low inflation, which has persisted since at least the financial crisis, could end. This presents an opportunity for investors to hold equity sectors that are geared to the economic cycle and will prosper from any upswing in growth, and a reason to be cautious on bonds.
At the same time, we continue to believe that a number of structural changes are at play within the global economy, and that businesses exposed to these themes can make attractive investments. Moments of market turbulence, when stocks in these often richly valued sectors are repriced lower, may present a buying opportunity.
Any research in this document has been procured and may have been acted upon by Close Brothers Asset Management for its own purposes. The information is being made available to you only incidentally. The views expressed herein do not constitute investment, taxation or any other advice and are subject to change. They do not necessarily reflect the views of any company in the Close Brothers Group or any part thereof and no assurances are made as to their accuracy. Investments may not be suitable for everyone. Past performance is not a reliable indicator of future results. The value of investments and the income from them may fall as well as rise and is not guaranteed. An investor may not get back the original amount invested. Unless otherwise indicated, all information and opinions expressed in this document are those of Close Brothers Asset Management and are correct as of March 2021.