The global economy has been plagued by unilateralism in recent years, and the lack of new mechanisms and new dynamics, coupled with the impact of the new crown epidemic, has left major economies facing unprecedented challenges. Entering 2021, the inflection point of the epidemic and the inflection point of inflation expectations have both emerged, and the inflection point of the global economy is about to emerge. After all, whether the epidemic is under control, whether multilateral cooperation mechanisms are smooth, and whether relations between major powers are normalized will all affect the recovery process. On the other hand, the global economic recovery will also bring various shocks, for example, inflationary expectations may lead to changes in monetary policies of major global central banks, and the recovery may bring sharp fluctuations in currency and stock markets, and so on. Therefore, we need to look at the path of global economic recovery in a prudent and rational manner.
The world was deep in recession in 2020, and only China maintained positive growth among major economies. In 2021, with the mass vaccination, the inflection point of the global epidemic is becoming clearer, and the socio-economic activities of the Western countries, represented by the US, are accelerating to normal. It is widely expected that the global economy will recover strongly in the second half of 2021; however, there are also concerns that the variability in the control of the epidemic will bring about an uneven economic recovery. When is the inflection point in the global economy likely to occur? And what will be the characteristics of the recovery?
The global economy will show an accelerated recovery in 2021. However, unlike the previous economic crisis, this round of recovery is characterized by unevenness, that is, the recovery of developed countries is significantly faster than that of emerging economies; and among developed countries, the U.S. economy will perform most prominently.
There are two reasons for this: First, from a public health perspective, the United States will be at the forefront of the world in vaccination. The ability to resume production and work depends mainly on the effectiveness of the prevention and control of the epidemic. And overseas control of the epidemic depends mainly on vaccination. At present, the U.S. is expected to be one of the first countries in the world to achieve mass immunization; the EU countries, despite the large amount of vaccine procurement, are not as secure in supply as the U.K. and the U.S., resulting in low vaccination rates, and emerging economies are even further behind the EU, so they may all face the risk of recurring epidemics, affecting economic recovery. Second, the financial relief policy is obviously different. After the passage of Biden’s $1.9 trillion spending bill, the fiscal stimulus taken in response to the epidemic has been equivalent to more than 15% of GDP, quickly filling the U.S. output gap, the Federal Reserve and the OECD (Organization for Economic Cooperation and Development) are expected to grow up to 6.5% of the U.S. economy this year. In contrast, Europe and Japan did not put in large-scale additional stimulus, while emerging market countries because of limited fiscal space, high interest rates, fiscal support is more limited. In addition, the faster pace of recovery in the United States will trigger a sharp rise in U.S. bond rates, but also intensify the pressure of capital outflows from emerging market countries.
In summary, it is expected that the “darkest hour” of the new crown epidemic will pass in 2021, along with the acceleration of vaccination. The recovery will be very strong, especially in the second half of the year. But globally, the recovery will be fragmented, especially in emerging market countries, which will face the double pressure of preventing the spread of the epidemic and preventing large-scale capital outflows.
At this stage, the global economic recovery path has two characteristics worthy of attention.
First, the global economic recovery is more likely to show a “Nike” type, rather than a “V” type. In the face of the impact of the new pneumonia epidemic as a “natural disaster”, the economy itself will be repaired faster than the substantial financial and economic crisis. At this stage, the epidemic is still significantly hampering economic activity. With the recent third rebound of the epidemic in Europe and the re-intensification of the embargo in many countries, the economic recovery, at least in the first quarter of this year, is not as expected under the ongoing embargo. Developing countries, on the other hand, are facing difficulties in accessing vaccines. Therefore, whether the global economy can show a significant “V” shape recovery in 2021 is still uncertain, and may be slower than expected, with a probability of a “Nike” type (slower rebound, longer duration) recovery.
Second, the U.S. economic recovery may exceed expectations, and the U.S. and European economic recovery may not be synchronized. With Biden in power, the U.S. epidemic prevention and control tightened, vaccine promotion accelerated, coupled with the passage of the fiscal stimulus package, the U.S. in the recovery track to speed up. International organizations such as the International Monetary Fund (IMF) and the OECD (Organization for Economic Cooperation and Development) have significantly revised upward their U.S. economic growth forecasts this year. On the contrary, in Europe, firstly, the vaccine promotion is far less than the United States and the United Kingdom; secondly, due to the difficulty of coordination, it is difficult to land its recovery plan quickly; finally, Germany, Italy and other countries will also face political instability factors such as general elections, all of which will make the European economic recovery produce variables, and the outlook is relatively gloomy.
People have now begun to hotly discuss inflationary expectations. Some studies point out that as early as the second half of 2020, global commodities have risen significantly, but did not trigger strong inflation expectations; since February 2021, along with the improvement of the epidemic, brought a climb in inflation expectations. Yields on Western sovereign debt, represented by 10-year U.S. bonds, continue to rise. Recently, the U.S. government passed a fiscal stimulus of $1.9 trillion, making people even more uneasy about the inflation that comes before the recovery. Has a new wave of sustained inflation been waiting for the opportunity to move?
There are many views that since the financial crisis, developed countries’ central banks have adopted super-easy monetary policies, including zero interest rates, negative interest rates and quantitative easing, but have never been able to raise core inflation upward, so the easing of this epidemic, and will not trigger inflation. On this, I beg to differ. In my opinion, the current round of response to the epidemic, developed countries, especially the United States, basically abandoned the fiscal restraint, its large-scale stimulus to monetize the deficit has been in practice, the risk of inflation should be greater than ever. This is mainly reflected in the following aspects.
First, the U.S. economic stimulus far exceeds the output gap. In accordance with the U.S. Congressional Budget Office estimates, the U.S. nominal output gap of $ 420 billion in 2021, but the Biden administration’s latest passage of 1.9 trillion fiscal stimulus scale, to significantly exceed this level, and thus will increase the risk of inflation.
Second, this recovery, the recovery in demand will push core inflation upward. In the past, the major central banks in response to the financial crisis, although put a lot of liquidity, but due to the lack of aggregate demand, resulting in the core inflation level is difficult to significantly higher; and the current round of the United States stimulus scale significantly more than the output gap, will push up domestic demand, leading to the core inflation index upward.
Third, rising commodity prices, climbing U.S. Treasury yields, and climbing asset prices all signal realistic inflationary pressures. This year, the accelerated rise in commodity prices, represented by crude oil, coupled with the recent U.S. 10-year Treasury bond yield also reaching 1.75%, has deepened the market’s concern about inflation.
Two dimensions. The first is the interpretation of inflation in the U.S. In 2021, the U.S. may become the “epicenter” of global inflation. First, the U.S. policy stimulus may be overkill. 2020, we measured the size of the U.S. fiscal stimulus accounted for 18.4% of its GDP in that year, while the OECD forecast the U.S. output gap of 6% in that year; 2021, the $1.9 trillion bill accounted for 9% of the U.S. GDP in 2020, while OECD projections for the U.S. output gap in 2021 and 2022 are 4.6% and 3%, respectively. Second, the U.S. may face the pressure of fast-rebounding consumption and fast-rising wages. At present, the U.S. job market recovery is slow, U.S. companies may have to raise wages, which will raise production costs and price pivot, intensifying inflationary pressure. Third, the low base of the U.S. last year. Assuming that PCE grows at an even pace this year (average monthly chain of 0.185%), U.S. PCE will reach an annual high of 2.7%-2.8% month-over-month in April and May, and may also be slightly higher than 2.5% in November. These are likely to be new highs since 2012.
Second, the interpretation of the commodity cycle. From a global perspective, the rise in commodity prices since the epidemic and continuing today is also an important reason for higher global inflation expectations. Data from the U.S. Energy Information Administration (EIA) shows that OPEC’s idle capacity is expected to remain at 7 million barrels per day in the first quarter of 2021, well above the historical high of 4 million barrels in 2009. In addition, global geopolitical games may also prompt oil-producing countries to strategically increase production. Therefore, the risk of inflation caused by excessive commodity price hikes may not be as severe as expected.
Many countries have adopted very accommodative monetary policies during the epidemic, and the U.S. is no exception. Although the current level of inflation is still within the target level and the Fed has not hinted that it will follow a pickup in real interest rates to raise rates; there is anxiety about the interest rate inflection point that comes with the inflation inflection point. Interest rates on sovereign debt in many countries have returned to or even higher than before the epidemic. How do the two feel the trade-off between inflation prevention and hope for recovery should be made? As inflation continues, when will there be a Fed rate hike and a global interest rate inflection point?
The pace of monetary policy tightening and loosening will be divergent this year. Emerging economies are the first to raise interest rates, on the one hand, to calm the pressure of rising domestic prices of food, fuel and other commodities; on the other hand, it is a rainy day hedge against the pressure of capital outflows that may be triggered by the rise in U.S. long-end interest rates. At the same time, countries such as India, which are highly dependent on energy imports, may also raise interest rates to quell imported inflationary pressures.
The developed economies, represented by the U.S., are a different story, with monetary and fiscal coordination rates or negative interest rates set to persist. On the one hand, the inflation targeting system is under scrutiny, as the Fed has switched to an average inflation targeting system last year, with a higher tolerance for PCE breaking 2% year-on-year in stages; on the other hand, monetary policy is more focused on economic growth and employment.
Inflation and economic recovery is the Fed and most central banks need to balance but is also extremely difficult to balance. We believe that ensuring economic recovery may be more important than preventing inflation from going higher. This can be understood in three ways: First, the current inflationary pressures are more likely to be short-term. The current supply-demand conflict in commodities is likely to be phased, and rising prices will naturally guide supply and demand toward a new equilibrium. According to the Federal Reserve’s latest forecast, while U.S. PCE inflation may significantly exceed 2% in 2021, inflation will remain around 2% in 2022, 2023 and the long term. This suggests that the Fed believes inflationary pressures may not last long. Second, compared to controlling inflation, the economic recovery is more difficult. Recessions may have inertia. If prematurely tighten policy to curb inflation, the United States may return to the “low inflation, low growth” state in the past decade, that is, inflation may be less than the target level for a long time. And this is the Federal Reserve does not want to see. Third, although central banks are stretched to push up inflation, but in the suppression of inflation can be full of tricks, as Powell constantly stressed, the Fed has sufficient tools to deal with higher inflation.
In addition, attention needs to be paid to the pressure on emerging economies to raise interest rates. We recently observed that Turkey, Brazil, Russia and other countries have begun to raise interest rates, for the global interest rate hike “to play the front”. At present, the spreads between European, Japanese and Chinese bonds and U.S. bonds have dropped to pre-epidemic levels. If the spread continues to narrow, it may trigger a new round of interest rate trading (Carry Trade). In fact, this is also an important trigger for the recent dollar phase strength.
Controlled epidemic and economic recovery is certainly a good thing, but it can also form a new shock. For example, the recent global stock market volatility increased, especially in China’s stock market; the property market in various countries also has the trend of heating up. Higher U.S. bond rates and a rebound in the dollar index will also have an impact on the currency market.