We take this opportunity to review the main themes influencing the global economy and financial markets and outline their implications for investors.
Vaccines and variants
One setback for global growth has been the emergence of the more infectious Delta variant of Covid-19. Nations like Australia and China have been forced to impose further restrictions, curbing economic activity. By contrast, the UK, US and parts of Europe with better-advanced vaccination programmes have been able to reopen their economies.
These different stages in tackling Covid-19 are driving a divergent global recovery.
Will inflation become entrenched?
Supply bottlenecks and energy base effects have driven up inflation, particularly in those countries that have been growing strongly. We expect these pressures to fade, although not until sometime in 2022.
There are also signs of wage pressures in some sections of labour markets. Could recent sharp wage rises become more persistent, stoking a longer-lasting inflationary spiral? Certainly, the data points to massive staff shortages and wage rises for sectors like haulage and hospitality in the UK, Germany and elsewhere.
However, there’s currently little evidence of big pay increases across a wider range of sectors and economies. Moreover, it’s important to recognise the huge distortions in the labour market resulting from Covid-19. For example, UK workers returning from furlough saw an immediate 20% increase in pay. Also, the concentration of redundancies among low-paid workers has the effect of pushing up average earnings in some wage measures.
So, while we see genuine labour shortages and wage inflation in parts of the economy, provided these pressures don’t become entrenched and spill over to other sectors, we expect inflation will ease in the months ahead.
Central banks on their guard
Nor will central banks stand idly by if high inflation looks like becoming entrenched - some are already shifting towards slightly tighter monetary conditions as economic activity picks up. The US Federal Reserve (Fed), for instance, has said it will start tapering its asset purchases this year.
However, the Fed has insisted tapering doesn’t herald the start of a rate-hiking cycle. By itself, we expect tapering will have only a minimal impact on markets.
US – hey big spender
US government spending has potential to make a huge difference to global growth. As things stand, both Democrats and Republicans are ready to pass US$550 billion in new infrastructure spending. However, President Biden’s US$3.5 trillion fully funded spending plan is fiercely opposed by Republicans, as well as some Democrats. It’s likely Biden will have to compromise. We expect a $2 trillion spending plan on top of the $550 billion bipartisan effort. This still represents a material boost to spending, with implications across markets. Climate, infrastructure and social care will be the areas to benefit most.
German elections – smaller parties hold the cards
With no outright winner in Germany’s election, the various parties are now negotiating to form a viable coalition. The outcome – and the direction of German politics – hinges on which of two small parties is part of that coalition.
The Greens favour expansionary policies aimed at promoting growth, especially in areas like climate solutions and social welfare. Potentially, this would be the more investor-friendly outcome. Alternatively, if the Free Democratic Party forms part of the coalition, government policy is likely to follow a more rules-orientated, EU-aligned path.
Climate – action, or more hot air?
Time is running out for planet Earth, and many see the UN Climate Change Conference (COP26) as our last chance. We’ll be watching for genuine follow-through action at individual country level, not just more vacant promises.
Enforceable climate laws
Climate action no longer hinges solely on governments. With emissions rules being written into law in many countries, courts can hold non-compliant governments and companies accountable. Clearly, this has major relevance for investors, who will be further incentivised to avoid companies with lax climate practices.
Central bank climate mandates
Central banks too are becoming more involved in the climate battle, by ensuring their financial objectives and policies are consistent with the country’s climate goals.
For example, the Bank of England recently announced it would target ‘green’ bonds as part of its monetary support programme. Similarly, the European Central Bank is mandated to ensure EU objectives – including climate goals - are fulfilled, albeit this is subordinate to its price-stability mandate.
A world in flux
More so than ever, the global economy is a story of many moving parts and possible outcomes. We believe it’s important to look beyond the near-term noise and focus on far-sighted companies with resilient business models that are able to grow and thrive as our world changes.