The economic cycle has advanced quickly. Conditions have already progressed from the recovery phase to expansion, in ANZ Research’s view, and this has important market and policy implications.
With ANZ Research’s forecasts at 5.5 per cent, 2021 is set to be the strongest year for global growth since 2007. Economies which didn’t return to pre-COVID-19 levels of activity last year are likely to do so in 2021.
Pacific Island economies are the main exception, where the importance of tourism suggests pre-COVID-19 levels of activity are unlikely before 2022.
The speed and vigour of the growth rebound is supported by four broad factors: the size of the policy stimulus, the relative lack of structural damage, vaccine development and the US Federal Reserve’s commitment to not raise rates until inflation is above 2 per cent.
The year 2020 saw the largest global downturn in a century but there is no precedent for the policy response. The nature of the stimulus and a less indiscriminate use of lockdowns as the pandemic progressed caused much less structural damage than might normally occur during a recession.
Rather than bankruptcies rising sharply during this crisis, in many economies they have actually fallen. While unemployment rose sharply in 2020, it has declined unusually quickly in many economies, with under-employment also declining in some cases.
Relatedly, banks have generally not finished this crisis with an overhang of non-performing loans which might normally crimp lending appetite and encourage caution. In reality there is an overhang of capital in some parts because provisions set aside in 2020 have proven to be surplus to requirements. Lending should therefore be quite responsive to any strengthening in credit demand.
Against this backdrop, the vaccine developments since November are very positive. There is of course some risk a variant of COVID-19 emerges which is not amenable to treatment. This should be treated as a risk scenario rather than being assessed as part of the central case outlook, in ANZ Research’s view.
Evidence suggests not only do the most prominent vaccines give protection to the recipient against COVID-19, but they also seem to, in large part, prevent the recipient from infecting others. The core economic implication of vaccine developments is the COVID-19 crisis largely resolves itself over 2021.
Against this backdrop, the US Fed’s stated intention is to be late in tightening interest rates. If the Fed is later in tightening than normal, then presumably once it starts to hike, it will need to move quickly. Other central banks, most notably the Reserve Bank of Australia, have adopted a similar stance.
This creates a particularly challenging cocktail for financial markets, and has been reflected in a pick-up in bond market volatility and the interconnectedness of risky asset prices. The changed behaviour of asset prices in fact is one hallmark of the shift from recovery to expansion.
Others include: much of the future increase in bond yields is likely to occur through the real component rather than the inflation component, risky assets are likely to be less correlated than they were through the second half of 2020 and the US dollar is likely to be less linearly weak.
Fiscal policy is likely to increasingly shift away from income support appropriate during a crisis towards addressing longer-term issues, such as infrastructure needs and climate change.
Businesses also are likely to, hopefully, start to find some capacity constraints as 2021 progresses, and we may start to see a return to stronger business investment. This would be consistent with a broadening and sustainable economic up-swing.
Somewhat unusually, Asia is likely to lead the monetary tightening this cycle. China began restricting liquidity in 2020. ANZ Research expects interest rate hikes in 2022 for South Korea, Indonesia, Malaysia, the Philippines and Thailand. Asia at the forefront of hiking rates is quite different from the post-GFC experience.
Along with improved current account dynamics, this is likely to give the region substantial resilience against the Fed’s eventual shift towards tightening, even if it is some time away. As such, it is advanced economies that would seem to be at greater risk of any eventual taper tantrum.
Over 2021, two particular issues are likely to garner increased attention. The first is calibrating the likely rise in inflation and the second is whether growth can remain stronger than what we were accustomed to pre-COVID-19.
ANZ Research has argued for some time the inflation dynamic out of the COVID-19 crisis is quite different to that emerging from the GFC. Market pricing now largely reflects this view. This makes analysing the inflation outlook a more nuanced challenge.
The pick-up in inflation seems to be something of a given. Base effects, supply chain constraints, shipping tightness and strong commodities suggest most economies will report meaningfully higher inflation this year.
For inflationary pressures to persist beyond calendar 2021, labour markets are likely to need to continue to tighten at a meaningful pace. At this stage that is ANZ Research’s expectation, but it will bear monitoring.
ANZ Research does not expect any advanced economies to raise rates over the forecast period to the end of 2022. But inflation forecasts for the US, UK, Australia and New Zealand suggest market speculation of rate hikes in 2023 is likely to remain quite active.
The recovery in global economic activity we anticipate over 2021 is unlikely to dissuade markets from this course of action. This recovery is likely to be as strong as any seen over the past 15 years.
In addition, consumption appears to be on a stronger footing than we have seen for some time, such that the cycle is likely to be more sustainable than the post-GFC growth spurts.
Household debt servicing in a range of economies, including the US, Australia and New Zealand, is at the most advantageous levels in decades. In fact, sustaining consumer demand will be crucial to tightening capacity use, and provoking a rise in business investment, which will need to occur if this cycle is to break the secular stagnation shackles of the GFC recovery.
Richard Yetsenga is Chief Economist at ANZ
This is an edited version of a piece which appeared in the latest ANZ Research Quarterly. Click HERE to access the full report.