Friday 30th July, 2021
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A raft of global economic data was released this week; and, for the most part, it confirms what we can see with our own eyes: growth is bouncing back right across the Western world as restrictions ease as consumers and companies get back to business. And this good economic news comes in the midst of the summer holiday season, so three cheers for timing!
Among major economies, America is out in front (of course) with GDP growing at an impressive +6.5% annualised in Q2. This means that the US economy has already broken through its pre-pandemic high water mark – a remarkable achievement given that only last year the US suffered its worst contraction since records began in the late 1940s, and much of the country was under a blanket of social distancing restrictions all through the winter. Interestingly, Q2 GDP growth still fell short of expectations because, while consumer spending rebounded strongly, private investment underwhelmed thanks to supply chain disruptions and growing labour shortages in certain industries. This suggests that US growth probably peaked last quarter, and that future readings are unlikely to keep pace with the last few blowout prints. Nevertheless, corporate results season has delivered a very high number of earnings beats, not least from technology giants like Apple, Alphabet, Microsoft, and Visa; and most economists forecast solid US growth through year-end (unless the spread of the delta variant forces a bigger re-think). Indeed, looking to the future, the IMF believes that the US economy could be even bigger in 2022 than it was expected to be before the pandemic… covid-19 be damned!
Nevertheless, inflation remains a wild card. In June, headline and core CPI reached +5.4% and +4.5%, respectively. There were many transitory factors that contributed to the rise in prices, and these were highlighted once again by the Fed Chair, Jerome Powell, in a press conference this week. However, it is also true that the labour market is showing multiple signs of tightness. Wages are rising at the fastest rate for 35 years now (+6.0% YoY last quarter), c.50% of small businesses are reporting ‘hard to fill’ job vacancies, and unemployment is sitting below 6%. At the same time, supply constraints are driving up input prices for US companies and compressing their net profit margins. If these producer price trends persist, a sizable share of higher costs will eventually have to be passed on to consumers. Inflation expectations might then shift higher, resulting in a more permanent (and worrisome) uptick in inflation. Moreover, the Biden Administration is spending like there is no tomorrow despite the US already being on the brink of a cyclical upswing. This summer the President is pushing Congress to agree to another USD 3.5tn in spending on social programmes, on top of a USD 1.2tn infrastructure bill that is likely to pass next week. A prolonged period of high inflation is not the Fed’s base case – or ours. But you would be a fool not to watch the data closely during Q3 and Q4 (when the distortive base effects will have begun to fade), and to hedge your bets when building your portfolios. Inflation risk is one reason that we have been positive precious metals for some time, and why we are running light on rate duration in our models.
European economies have also grown strongly in Q2, albeit from a much lower base, following a difficult first quarter. In Q2, Eurozone GDP expanded by +2.0% quarter-on-quarter, and the economy is now +13.7% larger than it was this time last year (following the huge losses during the first covid-19 wave). Nevertheless, given the -6.5% contraction in 2020 as a whole, there is still some way to go before GDP returns to its pre-pandemic scale (something that the ECB expects to happen in the middle of next year). One reason for the belated recovery is that the EU was slow with their initial vaccine rollout, a blunder for which it has paid a heavy human and economic price. But vaccination rates in most member states have now caught up with those in America, and we think that European growth is on a clear upwards trend (at least in the near-term). Flash July PMIs support this view with services and manufacturing sectors printing at 60.4 and 62.6, respectively (which is well above the 50 mark that separates positive from negative growth). Beneath the surface, there is plenty of dispersion in outcomes across countries and cases remain high and growing fast in many places. But the overall outlook has undoubtedly improved, and Europe can look forward to a better summer than many feared it would be in Q1 when a major wave of covid-19 gripped the block.
That said, the long-term outlook for Europe in general – and the Eurozone in particular – is pretty bleak. Hugely burdensome, if not completely unsustainable, public debts have swollen enormously due to the pandemic, and Southern European states that began in the worst fiscal position have faced the biggest hit from covid-19. This crisis has reversed all of the (admittedly meagre) gains that were made since the European Sovereign Debt Crisis, and the Eurozone has been left closer to the brink. Having lurched from crisis to crisis since 2008, what will happen when the next crisis comes? Could it be the finishing blow for the monetary union or will EUR limp on to fight another day? Once the immediate risk of a new wave dissipates and the long tail of the pandemic is in sight, we suspect that a more fractious Eurozone will emerge – and not a more prosperous one. Given decades of stagnant growth, how on earth will the Italian government pay off a debt that is now worth c.160% of GDP? The bond market is in denial. One plus point for the Eurozone (if you can call it that) is the relatively low risk of high inflation taking hold. The Eurozone’s (flash) core and headline CPI prints have come in at +0.7% and +2.2% YoY in July. We doubt that the ECB will need to step in to head off that mighty climb in prices, do you? As such, we see ultra-low rates and the bank’s EUR 1.85tn Pandemic Emergency Purchase Programme (PEPP) lasting for some time yet…
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