Flying on two engines

Flying on two engines

The long-awaited inflation spike has come. Price cuts in the early months of the pandemic are now dropping out of the annual comparison. Surging commodity prices and temporary supply bottlenecks are doing the rest. But we don’t see the pace of wage growth and degree of tightness in the labour market that could result in a more long-lasting inflation spiral. This is why we’re more dovish than market pricing and don’t expect any Fed rate hike at least for the next 2.5 years. To us, the key thing that’s happening right now is that the US looks set to bounce back strongly from here – as China did a couple of quarters back. Rather than just one global engine of growth, there are two now. And, in both, consumer spending and services are now supplementing the earlier drivers of manufacturing and goods. Combine this with ultra-loose fiscal and monetary policies, with more to come, and the near-term outlook is one where rotation, recovery and reflation are all supported.

Growth engine # 1 | The US consumer: The vaccine rollout is progressing rapidly, with over 38% of Americans having already received at least one dose. Fiscal policy is becoming even more expansionary: stimulus cheques – raised to $1,400 per person – are feeding through and reaching low-income earners with a high propensity to spend. Restrictions are getting lifted in several states. Retail sales, job creation, most key surveys and high-frequency indicators, as well as information from corporate earnings reports, all point to acceleration. Significant pent-up demand and large accumulated savings likely to be partially spent suggest very strong growth especially this quarter but also for the rest of the year, led by a surge in consumer spending on services and big-ticket items.

Growth engine #2 | China: The rebound in global industrial activity and international trade in goods from the depths of the Covid-19 shock a year ago has happened alongside significant divergences within Asia. China and Taiwan have been the biggest beneficiaries, with industrial production already much higher than pre-pandemic levels. We now expect a rotation from exports and manufactured goods-led growth to domestic demand and services-led growth – as vaccination ramps up further and the few remaining restrictions are lifted. As with many other aspects of the pandemic, China is earliest in this regional shift, with its own domestic restrictions falling close to zero in recent weeks for the first time since the pandemic began. This should reinforce the recent upswing.

Here’s why this matters:

Shifting drivers of activity: A key part of our macro outlook is the changing sectoral composition of growth we expect over the next two to three quarters. As economies reopen, consumption patterns across the world are likely to change. Rather than spending money on buying metals-intensive goods, ranging from home appliances to electronics as during the lockdowns of the past year or so, reopening is likely to support (and, finally, allow) spending money on oil-intensive services, like driving to eat out, visit family and friends, and travelling. The commodity angle is perhaps the most obvious here. But this way of thinking applies to sectors such as materials, industrials and consumer discretionary too, along with travel and hospitality, and beneficiaries of steeper yield curves.

The cycle around the trend: This early phase of the cycle may be quite different from the secular trends investors believe likely to play out – even if things ultimately turn out that way. This is because the assumption that an overarching theme consistently drives the cycle in each and every phase doesn’t need to be right. While certain underlying trends may be unfolding, such as decarbonisation supporting copper over oil in the long term, this doesn’t mean that oil can’t outperform for a more or less protracted period of time following a shock as big as Covid-19. Similarly, just because we don’t believe we’re at the onset of a period of sustained inflation, this doesn’t imply that we can’t have a temporary spike. Or, once the US and China normalise, that Europe can’t catch up at all.

Meanwhile, we should get confirmation that the US pickup is strengthening this week…

A differentiated picture: The purchasing managers’ indices for April should reveal strong momentum in the US, reflecting the increase in mobility and spending on the back of the recent reopening and extra stimulus. The picture should be similar in the UK, given the further relaxation of constraints to retail trade and hospitality. Manufacturing should have remained solid in the euro area, but the extension of restrictions in Germany is likely to have impacted services, while a new national lockdown in France should have caused a sharper economic contraction. The European Central Bank is likely to remain on hold, but the press conference should be interesting to get a sense of policymakers’ latest thinking. In Russia, following a surprise rate hike and an announcement that the central bank plans to return to a neutral policy rate (5-6%) in due course, expectations are for another rate hike to 4.75%.

Daniele Antonucci | Chief Economist & Macro Strategist