Global Weekly Commentary: A strong restart, not a recovery
We lay out three reasons why we see a strong economic restart, rather than a normal recovery, and believe markets still underappreciate its size and speed.
U.S. Treasury yields hit 13-month highs. We see the recent rise in real yields as justified given the growth outlook and remain tactically pro-risk.
Central banks in focus
Investor focus is set to shift to policy meetings of major central banks for their reaction to rising yields, after passage of the $1.9 trillion U.S. fiscal package.
We see the path out of the Covid-19 shock as a “restart” – not a typical business cycle “recovery.” The key reasons are the distinct nature of the shock, broad-based pent-up demand and different inflation dynamics. The passage of a $1.9 trillion fiscal package and an accelerating vaccination ramp-up in the U.S. magnify these factors, and we believe the restart will likely be stronger than markets expect.
Chart of the week
U.S. real GDP after past recessions and the Covid-19 shock
Sources: BlackRock Investment Institute, with data from Refinitiv, March 2021. Notes: The solid lines show the paths of U.S. real gross domestic product (GDP) during past business cycles and so far since the Covid shock. The dotted line shows our estimate of the consensus forecast based on reports from brokers that have updated their forecasts since March 6 when U.S. Senate passed the $1.9 trillion fiscal package. The level of GDP is rebased to 100 at the peak of each past cycle, and to the fourth quarter of 2019 for the Covid shock. Peaks of past cycles are as defined by the National Bureau of Economic Research.
We see three reasons why this is an economic restart, not a recovery – a distinction that matters for markets. First, we have stressed that the Covid shock is more akin to a natural disaster: economic activity is temporarily shut down, and then rapidly comes back online. The initial lockdowns in 2020 forced a halt in economic activity, triggering a plunge in U.S. real GDP, as the chart shows. Activity quickly rebounded in the second half as restrictions eased - and is now poised to leap forward as vaccines are rolled out. The restart is about turning things back on, not about the rebuilding of confidence that is needed in a typical recovery. The restart may be much faster than in typical business cycle recoveries as a result. We believe much activity will restart on its own, and won’t need policy stimulus as much as in typical recessions. We now expect U.S. real GDP to return to the pre-Covid level by mid-2021, far sooner than our expectation right after the initial shock. We see the new U.S. fiscal package bringing forward the return to pre-Covid trend growth by two to three years – further accelerating the restart.
The second reason behind a potentially much more powerful restart: broad-based pent-up demand. Consumer spending during the Covid shock has been unusual in that spending on services dropped sharply. The stoppage in activity and spending was mainly caused by lockdowns and not income constraints, and – unusually – affected all income groups. Household finances are in much better shape today than after the financial crisis, largely thanks to ongoing fiscal policy support. We estimate excess household savings in the U.S. to be about $1.8 trillion larger than in the year before the pandemic, with lower-income households supported by fiscal stimulus. This means that pent-up demand is broad-based this time.
The third reason: Inflation dynamics look very different today. A typical recession is caused by a fall in demand. Demand catches up only slowly to supply in a normal recovery, leading to disinflationary pressure. This is less the case today, as the Covid shock was caused by a fall in both demand and supply. Both have to catch up, in our view. We believe many companies have used the typical recession playbook by reducing capacity and cutting costs. Can they ramp up production fast enough as demand surges? A failure to do so would lead to additional near-term price pressures. Policy support has been extraordinary. We assess that the ultimate cumulative economic loss from the shock – what matters most for markets – will be roughly a quarter of that seen after the global financial crisis in the U.S. Yet the discretionary fiscal response so far is about four times larger, and the Federal Reserve has signaled it will be less responsive to rising inflation than in the past.
The bottom line: We see a much stronger post-Covid economic restart than what we would expect in a normal recovery. The rapid upward adjustment in U.S. Treasury yields and more muted movement in inflation-adjusted yields make sense in this respect, and are still consistent with our New nominal theme. The restart bolsters our pro-risk stance over the next six to 12 months, and makes us lean further into cyclical assets. We are overweight U.S. equities, and our preference for small caps extends to private equity and private credit. Elsewhere in private markets we like real assets as we see them offering some insulation against rising inflation down the road. We are also overweight emerging market (EM) equities, and see the recent selloff as an opportunity to add to this asset class. We still expect EM equities to benefit from a global cyclical upswing, supported by a stable U.S. dollar. The commodity price rally should also help resource-rich EM economies, in our view.
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