The Wellington Global Cycle Index1 points to an upturn in global economic activity but, in my view, even that positive prognosis is underestimating the bounce that’s ahead. Over the next six months, I predict that growth numbers almost everywhere will be exceptionally strong.
Where we differ from consensus
Almost all analysts now have the same broad roadmap for 2021 as we have — strong growth, with a gradual rise in inflation through the second half of 2021. All list the same set of risks: upside risks are attached to a full household-savings unwind and another round of fiscal support, while downside risks are attached to public health. All assume US growth leadership. What is striking is how there is actually very little discussion of inflation.
As economies reopen, it will be difficult for the market to distinguish between the varying degrees of strength of individual countries’ economic recoveries — it will just appear strong. But looking at the path over the next six months, there are some notable differences between our view and consensus which I think are interesting.
- Better-than-expected growth in China and the euro area. Over the past month, the Street has downgraded its China and euro-area growth projections. We expect both regions to surprise to the upside over that time frame.
- Higher inflation in the US and UK. Although the market expects strong bounces in growth in the US and elsewhere, it assumes the rebound is, at least initially, non-inflationary. We expect the rise in inflation (when it comes) to be more persistent, as the labour market rebounds quicker than both consensus and central bank forecasts.
For equities, an improving macro outlook matters to the extent that it materially alters the path for global excess liquidity. That’s unlikely to happen over the next six months.
Equity prices — and those of other assets — have benefited from the surge in real (after inflation) M1 money supply, unprecedented expansion in central bank asset purchases (US$6 trillion over the past year) and the associated squeeze in real interest rates. No major central bank is in a hurry to remove the stimulus. In fact, as growth explodes upwards, central banks will continue to add even more liquidity into the market — we estimate global central bank balance sheets will expand by another US$1.5 trillion over the next six months. These liquidity measures imply even further upside potential. Global real M1 growth is likely to remain in double digits through the next six months, which should point to continued outperformance of equity returns over fixed income but is unlikely to prevent yield curves from continuing to steepen.
However, if our cyclical roadmap is right, conditions will shift and become less supportive for markets around the turn of the year, even under the US Federal Reserve’s (Fed’s) current, more relaxed inflation policy. “Early” cycle could start to feel more “mature” cycle as the second half of the year progresses, once inflation and labour markets have rebounded enough to restore central banks’ confidence in the outlook. At that point, the market will have greater clarity on when the excess liquidity in the system will begin to reverse, as the Fed tapers — and other central banks end — their asset purchases. Nonetheless, even at that point, I believe we will likely still be some way off rate hikes.
1 The Wellington Global Cycle Index is a proprietary index constructed by Wellington Management to quantify trends in global economic activity, based on a number of forward-looking macro variables and assumptions.