One quarter down, three to go

by | Mar 30, 2021

As March ends and we enter the second quarter of 2021 we look at a few of the major factors which will shape the economic backdrop for the remainder of the year. We specifically look at the global growth outlook, inflation expectations and currencies.

The expectation is for the global economy to recover over the remainder of 2021. Currently analysts expect that growth will initially recover faster in the U.S. compared to the rest of the world, with Bloomberg showing a consensus view of U.S. real GDP growing by 4.8% in Q1, with the Euro area, UK and Japan expected to contract by 3.6%, 13.3% and 5% respectively.

There are two reasons for this expectation. Firstly, the U.S. has had a very successful launch of its vaccination campaign.This has allowed for the easing of lockdown measures and for economic activity to recover. Figure 1 shows how lockdown measures have been disabled at varying paces across the world.

Currently the U.S. has administered 40 vaccines shots for every 100 inhabitants. Of the major economies only, the U.K. has performed better on this front. See Figure 2.

Secondly, the U.S. has undertaken an enormous amount of fiscal stimulus. This not only in absolute terms but as Figure 3 shows as a percentage of GDP too. On the 11th of March, President Joe Biden signed the $1.9 trillion American Rescue Plan Act into law. Among other things, the Act provides direct payments to lower-and middle-class households, extends and expands unemployment benefits, and offers aid to state and local governments.

What is interesting is how this plan varies in terms of the distribution of benefits for the poor versus the rich. This contrasts President Trump’s Tax Cuts and Jobs Act which benefited the wealthy to a much larger extent. See Figure 4.

BCA Research expects that in the second half of this year there will be a shift in growth leadership from the U.S. to the rest of the world. The EU will benefit from such a recovery later this year once the vaccination program gains momentum. To date the weakness in Europe was concentrated in the services sectors, however the latest Purchasing Managers Index (PMI) data shows that it is in expansionary territory. As in the U.S., European households have accumulated significant excess savings. The unleashing of pent-up demand should drive consumption over the remainder of the year.

The U.K. which was dealt a double blow late last year should also see a recovery in the coming months thanks to their rapid vaccination program and the lifting of lockdown measures. The U.K. had to shut their economy after the emergence of a more contagious strain of the virus on top of a decline in exports following Brexit.

U.S. inflation expectations and the consequent path for interest rates has been a much-debated topic. The questions being, will the U.S. economy overheat, forcing the Federal Reserve (Fed) to increase interest rates? The fact is that U.S. households were sitting on around $1.7 trillion in excess savings in January 2021. About two thirds as a result of reduced spending.

The recently passed stimulus bill will further boost savings by $300 billion. This will be supportive of spending and so an increase in demand. Under the stimulus bill, close to half of jobless workers will receive more income through to September from extended unemployment benefits than they did from working. This could result in less labour supply (from people staying away from work) at a time when firms are trying to hire more. The result of this dynamic is that unit labour costs will rise and so drive-up inflation. Despite some evidence to the contrary, the Fed does not believe that this negative output gap will lead to materially higher inflation. In the latest Summary of Economic Projections released last week, the median “dot” for the fed funds rate remained stuck at zero through to end-2023. See Figure 5.

It is BCA research’s view that inflation will likely remain fairly subdued in the short term (over the next two years), but could rise significantly towards the middle of the decade. This will force the Fed to raise interest rates once more.

Now to touch on currencies. In the near term, faster U.S. growth relative to global growth, should be supportive of the dollar. The U.S. has a low beta economy, meaning U.S. growth is less volatile than growth abroad. While the U.S. economy benefits from stronger global growth, the rest of the world benefits more. This countercyclical nature of the economy has important consequences for the dollar because when global growth is higher than U.S. growth, capital tends to flow out of the U.S. into other markets, weakening the dollar in the process. As a consequence of the aforementioned factors, the U.S. economy is enjoying relatively higher growth. However, this should reverse over the second half of the year, and so we could see a weaker dollar over the coming months. The Fed has also reiterated their commitment to ultra-easy monetary policy (low interest rates) through to 2023, which will further be supportive of a weaker dollar. In an environment where global growth improves, cyclical currencies such as the euro, pound and emerging market currencies like the rand tend to appreciate.

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