Perspective

Waiting for the cavalry


News that a Covid-19 vaccine is on its way has provided a boost to the outlook for the world economy and spurred a significant rally in equity markets. There is, at last, some light at the end of the tunnel. The vaccine should, eventually, bring a return to normal social behaviour and an end to the restrictions which remain in place in many parts of the world.

Our forecasts factor in a difficult winter before the vaccine brings a stronger recovery in activity in the second half of 2021. We see the recovery extending into 2022 as fiscal and monetary policy remain loose whilst activity normalises. Growth is expected to continue at an above trend rate throughout the forecast. Meanwhile, inflation remains relatively contained with only a modest pick-up in response to higher commodity prices.

Such a pattern is typical of the recovery phase in the cycle. Our forecast for the next two years looks very similar to the bounce back from the Global Financial Crisis (GFC) in 2010 and 2011.

Global GDP growth in 2020 has been upgraded to -4.0% from -4.3%, driven by a revision to the emerging markets (from -2.7% to -1.9%) reflecting better growth outside China

We would have revised up by more on the vaccine news, but we face a period of weaker activity in the near term. We anticipate more restrictions in the US and expect the second wave in Europe to result in a negative quarter of growth in Q4. These effects roll into Q1 next year.

In addition, our central assumption of distribution and sufficient immunity for more normal activity to resume in the second half of 2021 remains intact. There is, however, a possibility that the vaccine may arrive and be distributed earlier.

Assumption of a fiscal stimulus in the US of $1 trillion, while central banks keep the monetary taps on through the forecast

Our assumption that a $1 trillion deal is struck in Q1 is based on the view that president elect Biden can strike a deal with Mitch McConnell the leader of the Senate. The two men have struck deals before (when Biden was vice president) and concern about the impact of the third Covid wave should be sufficient to persuade the Republicans that something needs to be done.

Meanwhile, the Federal Reserve (Fed), European Central Bank (ECB), Bank of Japan (BoJ) and Bank of England (BoE) keep rates unchanged through the forecast period. We expect inflation to be low and stable and central bankers remain wary of the risk of deflation. The Fed's new framework means that we will need to see a period of 2%-plus inflation to hit the average inflation target. That means zero interest rates and continued quantitative easing (QE).

However, the recovery will also mean that QE will moderate. QE continues around the world with the result that the Fed balance sheet soars to around $9 trillion by the end of the forecast period. This is an increase of nearly $2 trillion from today, however the pace of QE will moderate to around $100 billion per quarter by 2022 compared with its current pace of $360 billion. This may trigger another taper tantrum.

The US dollar weakens even further

Two factors are expected to soften the dollar further.

The first is the arrival of President Biden and the reduction in US-China tensions, which reduces the attraction of the US dollar (USD) as a safe haven.

The second is the likely return of the twin deficits. The US budget deficit is on track to reach $3.5 trillion, or 17% of GDP this year and although it should narrow as economic activity recovers in 2021, the overall current account deficit will increase. Given that a significant portion of the budget deficit is structural (around 5.5% of GDP), the US looks to be heading for a twin deficit problem. This would herald a spell of dollar weakness as the economy becomes dependent on external funding.

 

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This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
This material, including the website, has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.

Important Information
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
This material, including the website, has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.