Weekly Macro Update: Coiled Spring
Exceptional garden pinks and yellows mark the arrival of seasonal spring, but the world’s economic data outline a “coiled spring,” to borrow a phrase from Bank of England’s Andrew Haldane. Expanding vaccination programs, generous government spending, cheap money, and strong household balance sheets all point to a global economy that is about to pop. Lingering concerns around COVID cases in Japan and other emerging markets paint a gloomier picture, but those risks have also kept yields from rising too fast as some investors seek safety in U.S. Treasuries.
Listening to our investment teams, we still seem headed for “The Best of All Possible Worlds,” a scenario of strong growth, temporary inflationary pressures, and a supportive backdrop for risk assets, including equities, credit, and private markets. Whether this picture proves durable over a longer term remains uncertain, but we continue to assign it 50% odds over the next 12–18 months. The euro may continue to regain some of its ground against the dollar as European growth accelerates over the next few months. Duration may benefit, too, as yields drift lower amid stubborn pandemic pockets and fears the recovery may stall in the face of large, new U.S. tax increases. Still, these trends will likely prove temporary with the arrival of much stronger summer data.
“Inflation Anxiety” that could force a much sharper rise in yields and a tightening of financial conditions remains the biggest risk to our base case, and we maintain this scenario at a 30% probability. Price data surprises will spook investors given the strength of the recovery, rising demand for commodities, and global supply bottlenecks even if we remain confident these pressures are transitory. If anything, the odds that “Gravity Prevails” as demand sputters out or governments tighten too soon look slimmer than ever, but a resurgence of new pandemic strains might force a reassessment.
Restrictions are easing in the United States faster than elsewhere, which, when combined with fiscal stimulus, is supporting strong in-person consumption. Moreover, additional fiscal spending should provide more fuel for growth. Base effects and energy prices have begun to boost inflation, but persistent price pressures are nowhere to be found. Despite rising inflation, the 10-year Treasury yield has drifted lower since the end of March. Tax increases to fund further spending have been announced but are likely not fully priced in.
In Europe, thanks to vaccinations finally taking off, tourism may provide a significant boost to growth this summer. With consumers in the starting blocks, the momentum is building for strong Q3 performance. There is room for financial markets to continue rallying. Without any ECB tapering in sight, financing conditions keep as supportive as ever. A sustained recovery will require investments from the Recovery Plan to raise productivity.
The pandemic remains a risk in Asia, where vaccine rollout has only inoculated a small part of the population. China’s rebound is broadening as consumption activity perks up after the Lunar New Year lockdowns. Exports have been a source of strength for the region, with China providing the anchor. In Japan, the consumer outlook is more mixed, despite there being ingredients for a decent rebound. Persistent COVID outbreaks and social distancing restrictions mean the job market has yet to completely heal. A strong export environment and broadening economic growth outlook should provide further lift to Asia FX.