More than most Septembers, spring seems like a long time ago. Beyond nature’s promise of new growth, investors basked in a world on its way to reopening. Since then, spiking contagion, lingering bottlenecks, and a Chinese slowdown have raised fears of a gloomy winter ahead.
These concerns are real, but they do little to alter the simplest way to describe the global economy through the end of next year: strong growth and benign inflation. The latest developments may well have delayed the arrival of something approaching a return to normalcy—but this moment will come. While we have slightly reduced our growth expectations for the U.S. and China this year and bumped up our number for European inflation, we continue to believe we live, as investors, in “The Best of All Possible Worlds!”
To be sure, growth indicators have been weakening simply because the breathtaking acceleration following last year’s lockdowns was unsustainable. In most developed countries, however, PMI readings remain comfortably in expansion territory. Meanwhile, consumer balance sheets and corporate capital expenditure programs promise continued strength, even if the recent challenge from the Delta variant delays the recovery in travel and hospitality industries. Successful vaccination programs seem to have weakened the link between contagion and fatalities, bringing the world one step closer to living with the virus.
Major central banks’ moves towards slightly less accommodative policy reflect the strength of the recovery underway, even if its impact will be uneven across different economies where vaccines remain in short supply. Indeed, vaccine availability and continued effectiveness are the central risk to growth. Another risk is the end of extraordinary unemployment benefits in the U.S. on September 6, although a strong job market and healthy consumer appetite should smooth the transition.
With further recovery still ahead for lagging pockets of the global economy and policy makers fully aware of the perils of premature tightening, the next 12–18 months should be a period of good returns in equities, private assets, and Emerging Markets. U.S. rates should drift higher towards 2%, a move likely to be repeated by other liquid sovereigns, as central banks exit emergency measures in well-advertised baby steps, and the dollar should glide lower as the global recovery takes root.
In the United States, protracted supply chain bottlenecks are keeping supply from catching up to demand, and temporary constraints on some parts of the labor force are further weighing on the recovery. However, strong demand still supports the business outlook, cushioning the impact of higher input prices. COVID cases and deaths are rising, particularly given slowing and lower vaccination rates. But the impact of rising infections on activity data looks much less severe this time and so far shows little impact on final demand and spending.
European economic activity continues to accelerate, while labor demand is recovering well across the continent. Confidence is fostering consumption, even if wages are lagging. Higher vaccination rates should help contain risks from the Delta variant. But bottlenecks are hurting the recovery in Germany and supportive policy will continue to be important. German elections represent a risk if they lead to new calls for balanced budgets and higher policy rates.
In China, a recent tightening bias is likely over amid continued efforts to rebalance the recovery. Consumption has been faltering slightly on continued COVID-related restrictions to activity, but investment should continue strong amid higher fiscal spending and robust industrial profits. In Japan, the recovery has been tilted towards industrial production, which continues to hold up. The consumer demand recovery may remain volatile, but there is hope as vaccinations ramp up. For the rest of Asia, manufacturing remains mostly supportive, but is moderating.