The global economy sheds off lockdown blues

09 September 2021

The vaccination rollout continues to make significant headway in major economies such as the United States (US) and the United Kingdom, with roughly 49% and 57% of the population being fully vaccinated respectively at the time of writing. Encouragingly, roughly 15% of the world is now fully vaccinated, according to the latest figures from Our World in Data. Against this backdrop, markets enjoyed an exemplary run over the last quarter, with the FTSE All World Index up 7.4%¹ over the three months to June 2021 amid unprecedented monetary and fiscal policy support from global authorities, particularly in the US.

The reflation trade took centre stage over the quarter with the Refinitiv/Core Commodity CRB Index returning 15.4% while oil, in particular, rose 24.5%. Unsurprisingly, this came amidst elevated inflation statistics on a global level, amid a low 2020 base that exacerbated the rate of change in the data, as well as strong demand-pull inflation and supply-chain disruptions. The persistence of the latter is important to note since, according to the latest JPMorgan Global Composite Purchasing Managers’ Index, it continues to exacerbate both input and output prices. Nevertheless, the survey also pointed out that business optimism improved to the second-highest reading on record and is especially evident in the developed market world. This can likely be ascribed to the easing of lockdowns amid a successful global vaccination rollout to date.

DEVELOPMENTS IN THE US

Some noteworthy policy and forecast developments by the US Federal Reserve (Fed) have also taken place more recently. While the Fed opted to keep the federal funds target range unchanged at between 0% and 0.25%, and the monthly asset purchasing programme at US$120 billion, the Federal Open Market Committee (FOMC) elected to hike the interest on excess reserves and the overnight reverse repo rate by five basis points. This attempts to keep funding market rates from going below 0%. Unsurprisingly, however, the committee also upwardly revised gross domestic product (GDP) growth and personal consumption expenditure inflation forecasts this year to 7% and 3.4% respectively, from projections of 6.5% and 2.4% recorded in March. In fact, GDP growth in the US registered an increase of 12.2% year-on-year in the second quarter – an increase not seen since 1950s. Strong consumption data bolstered economic activity amid sizeable stimulus checks under the Biden administration.

Another significant development from the FOMC meeting is that  13 out of the 18 committee members are now signalling that they expect at least one 25 basis points rate hike in 2023 as indicated in the Fed’s dot plot.

Despite a more hawkish tilt and firmer talks of tapering imminent, cross-asset volatility remains well contained for now. While the latest Fed minutes stated that conditions for a reduction in asset purchases have begun to materialise sooner than expected, amid strong economic data releases, the committee did acknowledge that the economic recovery was still incomplete. Specifically, their expectations of a broad-based and inclusive maximum employment goal were weaker-than-anticipated. This likely indicates that the Fed will err on the side of caution and adopt a wait-and-see approach before commencing on a path of tapering asset purchases.

A moderation in liquidity will likely have a negative contagion effect by spilling over to global equity markets and spark risk-off sentiment if the scaling back of asset purchases proves to be sizeable. As we delve deeper into the second half of the year, the investment climate will certainly be more challenging as global growth momentum begins to lose steam. 

AN EYE ON FIXED INCOME

The first two quarters of the year have had contrasting returns in the fixed income space. In the first quarter, the Bloomberg Barclays Global-Aggregate Total Return Index fell 4.5% amid synchronised sovereign yield curve steepening from higher growth and inflation prospects being priced into global bond markets. However, in the most recent quarter, the same index rebounded 1.3%. In particular, the US 10-year bond yield commenced on a downward trend amid lower fiscal issuance, a substantial increase in speculative bond positioning and softening data releases, albeit relatively robust by historical standards.

To this end, growth stocks have found renewed impetus as the lower cost of borrowing has supported a broader re-rating. This is clearly evident in the technology sector.

A WORD ON CHINA

It is worth noting that China remains one of the few markets to underperform the global economy and is among one of the worst in the emerging market basket. The emergence of lower growth and rising inflation has quelled support for the Chinese equity market. In addition, haphazard regulatory pronouncements in the technology sector have certainly sparked jitters among market participants. 

The most perturbing of all, however, is that the Chinese credit impulse has delved even deeper into negative territory. Given its strong leading indicator properties in relation to the global cycle, this is signalling that the second half of the year will almost certainly experience slowing growth momentum. Similarly, the global thrust from fiscal stimulus has been largely front-loaded, predominately in the US; hence the level of accommodative policy is unlikely to be as supportive in the future.

GROWTH EXPECTATIONS

Despite the above, on a full-year basis, global growth rates are expected to more than offset the downturn last year as precautionary savings fully unwind, and as economic activity recovers off a low base. The vaccine rollout continues to be a positive for the global economy as lockdown restrictions keep being lifted. Global inflation is likely approaching its peak and is expected to slow in the second half of the year. 

While there are certainly reasons for cautious optimism, it is important to remain on high alert, particularly if global liquidity is drained from financials markets.  

1 All statistics in USD terms unless stated otherwise.

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