Aurelia Sax (AS):
Welcome to PineBridge investment podcasts. I'm your host Aurelia Sax, deputy head of Client Services EMEA at PineBridge. Every month we'll discuss different topics at the intersection of markets, geopolitics and investment, sharing PineBridge takes on the latest trends as well as their potential impact on markets and portfolios. Today I'm speaking with Markus Schomer, PineBridge chief economist. Markus welcome.
Markus Schoomer (MS)
Hi. Aurelia, nice to be on the podcast.
We will discuss what investors might expect looking ahead to 2021 and the risks and opportunities that exist in an uncertain market like that. Markus it is extraordinary to think about where we are now compared to a year ago. Governments across the globe are rolling out a highly effective COVID-19 vaccine. The Democrats not only won the presidency, but also control the House and Senate, enabling fiscal spending on a much higher level than anticipated. Vaccines and stimulus combined with ongoing monetary support supplied by the Fed and other central banks has seen indices recover to new high.
Judging by markets, it's almost as the pandemic never happened. But something tells me it isn't the full story. So in your outlook you expected a transition from the pandemic to a more normal business cycle. Given what you've seen, where do you think we are in this path?
Well it's amazing what has happened even just in the last six months since we presented the investment outlook for the year. At that stage, we hadn't even heard about the pandemic, really. And the election you mentioned in the US was still ahead of us. But looking at where we are now, in the summer of 2021. On the one hand, it's definitely fair to say we've come a long way and you describe some of the issues that we've been watching and monitoring over the last couple of months, which is infection trends. We had a pretty dark winter in the US, but also in Europe. But now in at least in those two parts of the world, they are really enjoying very successful vaccination trends. But the pandemic is not over right, we're seeing a resurgence in the UK right now. and Europe is sort of bracing for this new Delta variant to become quite dominant and virulent in other countries in Europe. And I think here in the US, for example, we also are not out of the woods yet either.
Although the vaccination is a really good firewall to prevent another significant impact on the healthcare system, which was always the reason why governments around the world used these harsh measures like lock downs, to combat these infection waves, I don't think we're going to go back to those. The numbers themselves will still go up and down. And we're also focused on tracking this, I think that will not go away, but the impact on healthcare and then therefore, the impact on the economy will not be as harsh and negative as it was last year.
It is still surprising to me that we're not deeper into getting past a pandemic and also how asynchronous, the impact is on the rest of the world. Asia, for example, never got hit as hard, but also hasn't really done a great job in terms of vaccinations. There's a lot of catch up going on right now in places like China and Japan but they're lagging behind certainly where we are in the US, but also where the Europeans have come to.
And of course, we have the entirety of emerging markets where vaccination supply is just still the most important problem. And even though the developed world is doing quite a lot to ease those supply concerns in emerging markets, it will take probably deep into next year, maybe towards the end of next year before, we can really get to a point where a large enough part of the entire world, of the entire global economy is vaccinated to the extent that we can say, global herd immunity has been achieved. So I think the pandemic is going to linger around for longer than I certainly thought six months ago when we initially thought about what could happen this year.
Thank you for this overview Markus. One of the new themes everyone is talking about is inflation. How real is the threat of rising prices? Or is it transitory as Fed chair Jay Paul's keeps telling us?
Oh, yeah, this is the big theme right now that we're talking about. There was some hints that this could be a risk for this year. Again, when we wrote the initial outlook, but I think to the extent to which inflation has accelerated, in particular in the US, is one of the surprises, I'd say. And I think what we're seeing here is a bunch of things coming together.
First of all, let me also just mention you, you highlighted the Feds view on this, pointing out that inflation is likely transitory and therefore doesn't require policy action. I think that's probably a view shared across most of the central banks around the world.
But it's, of course, an interesting debate. I think that inflation is always transitory, right, unless it leads to a rise in wages. Because if prices rise, what happens is real purchasing power of consumers declines. And if prices rise for a number of months for, you know, a quarter or two, then consumers will start to feel that in their pocket books and they start spending less money because spending on energy, for example, is going up and that has to be substituted if you don't get higher incomes. And we're not really seeing a lot of evidence that wage growth is picking up in response to the increase in inflation.
So in a way, that transitory debate is somewhat mute, because inflation is always transitory because it will always slow growth. But what's coming together here is actually a combination of two things. It's not just the fact that we have too much demand, we had a lot of stimulus in the system, people are sitting on a lot of savings around the world because they just couldn't spend money last year, and that money is now being released as the economies are reopened.
And that excess demand that you're seeing in the economy right now is driving up prices. But in addition to that, we also have, you could almost say a bit of a sort of mini supply shock, because of COVID restrictions, because of disruptions in supply chains, to some extent, because of the different timelines that COVID still has around the world, where things are easing off in the US, but they're still tightening in some parts of Asia, that impacts global supply chains. And we're seeing significant problems right now, on the supply side, where companies are just not able to get enough inputs into their own production processes to fulfill the demand.
So you have this double whammy of supply constraints and stimulus plus COVID restriction easing, fuel demand surge, and that's really coming together right now very, very powerfully, and you see inflation trends going up everywhere in the world. But so far, there also is still quite a difference between the 5% inflation we have in the US right now, which is worrying. I think 2.1% was the last inflation point in the Eurozone, which is just about what central banks would like inflation to be. Right 2% is everyone's inflation target. And then you go over to Asia, and you see that inflation in Japan is still negative. So it's not that there's an inflation surge everywhere in the world.
When it comes down to consumer price inflation which is what matters to central banks, it is very much a US problem with other parts of the developed world facing a pickup in inflation, yes, but not to the extent that what we're seeing over here in the US. And I think that's still a critical difference. If it was more a more unified surge in inflation, I think I would be much more worried. The fact that it's more of a US phenomenon. I think is connected to the fact that we just introduced the biggest stimulus packages, and I'm not sure how many more of those are on the horizon.
But I think that big sort of fiscal emergency stimulus push that we had, at the end of last year, early this year, I think it's fading. So the demand element, at least of this inflation push in the US, probably won't last much longer. So in that regard, I think I'm a little bit in the transitory camp that Fed chair Powell seems to be in as well.
Very interesting. Will global central banks' policy continue to dominate asset allocation decisions? Or will investors increasingly focus on macroeconomic factors?
That's a good question Aurelia. This goes back to something that I've been talking about for quite a while now. And it's this idea that we're increasingly living in a world where the dominant drivers of financial markets are not so much macro factors anymore, growth rates, productivity numbers, even employment numbers, but increasingly, policy actions by central banks. but as we've seen recently, also by fiscal authorities.
Those are the dominant drivers of financial markets and not so much macro anymore. And by saying that I'm also implying immediately that policy and macro are not really connected anymore. And I think that was one of the big lessons from before the crisis. If we all remember, just a few years ago, we had a situation where the Fed tried to end QE, but had to bring it back because markets became too unstable after a while living without QE in the US.
And the same thing happened in the Eurozone, the ECB tried to stop its QE program that was trying to deal with the crisis from 10 years ago. They tried to wean markets in Europe off QE but couldn't do it either and had to reinstate the program before the pandemic started.
So we already were living in a world where it was increasingly about policy about central bank action in particular, then that markets reacted to and not so much anymore, whether growth in the US was 2.3, or 2.4%, or whether inflation in the Eurozone was 1.1 or 1.2%, those little macro economic differences didn't really translate any more into significant market performance and our focus at PineBridge, where it's all about getting markets right, but not a research house for economics, or what we're trying to do is help get the direction of financial markets right.
So we have focused more on getting our policy calls right, rather than getting macro economic calls right. And I think that's still a world that we live in and central bank actions going forward will be very important. Just look what we're doing right now and over the last few weeks, we're all debating what the very latest fed meeting means for interest rates and for the future of bond purchases, are they signalling that we're coming towards the end of QE, are they signalling that we will see the beginning of the tapering of asset purchases, and
over in Europe, it is in a very similar situation, they have a QE program running that is supposed to expire in March. It's only June but eventually March will come close and you have to tell us a little bit more what you're intending to do.
So the focus, I think, in the second half will be very much on the decision that these two central banks will take, whether QE will just continue into the future, or whether we are at a point where central banks feel confident enough to, I would say wean the market off the constant money printing.
But this will be very difficult because the QE programs are very large, debt levels in the world are very large. And the economies I would say, are still very fragile. They have not settled yet into a proper, post COVID world.
So in that regard, the action by those two central banks and other central banks around them as well, I think will be more important for the direction of financial markets than what the actual market economy is doing the second half.
Thank you very much. And how do the key developed world economies stack up in the recovery ranking, in your opinion? And what about the key emerging market economies?
Yeah, this is probably one of the themes I think will be important. If you look a little bit further across the time horizon, when we do a media outlook, we're kind of trying to look back a little bit, what did we think was important for this year? And what will the second half of this year look like? But of course, we never just constrain our time horizons in that way. So what we're really interested in is what is the next theme? inflation is important, but it is the current theme that everybody talks about, right. The fact that central bank actions will be important for the second half is important to know. And we will definitely pay attention to this.
But the really important thing for us in PineBridge, where we're more intermediate term investors really is to identify what is the next theme, what is the next theme that the debates, the markets, the pundits will latch on to that will drive financial markets. And I think one of those themes in my view will be where do the economies settle when everything is said and done. So to that extent, I'm spending a lot of time right now, trying to see where we actually even are. And the difference between economies that did not suffer much of a recession last year and those who did is still a very, very wide, astonishingly wide.It's much wider than for example, the differences between financial markets, which is another way of saying that macro is right now not that important, right.
But clearly if countries like Taiwan, for example, that never really faced a harsh recession in the first half of 2020 and because of strong growth, they're lucky to be perfectly exposed to the surge in tech investment since COVID. Their economy has surged way above where it was before the recession, and even well above where it would have been had just the growth of the previous years prior to the recession just continued.
If you draw a straight line, a trend line, through Taiwan's GDP numbers, they are well above it, compared to where they would have been without COVID. So they are one of the big beneficiaries. On the other hand, the UK, for example, is still very much at the back of the train carrying a significant amount of damage from this COVID recession into 2021.
Now, some of these recession gaps, as I started to call them, will close in the next few quarters. Most of these economies that have been lagging behind, many of them are European economies, by the way, are now reopening and they're seeing a surge in demand, which will translate into a surge in GDP growth over the summer.
And that will help them close those gaps. But it is still very, very obvious if you look at the evolution of GDP growth across the key developed world economies, that there is a very, very stark difference between -I mentioned a few others, for example, Hong Kong, or Norway or New Zealand, all countries that have been doing really, really well, the US is very much in the middle of all this and then places like France, Italy, UK, and Spain at the back of that trend.So the convergence of GDP performance across these countries will be one theme.
But where we live, we settle at the end of this will be, I think the next theme. And in a way that's going back to where we came from. where we lived in a world where the EU, or the US had the strongest potential underlying growth rate across the major developed world economies, the Europeans were quite a bit behind. And then countries like Japan even further behind.
I think that will become important again in a few years. So we will try to pay attention to see what happens to these underlying growth trends, has there been any difference in productivity growth, we're not even sure exactly where labour force growth will settle. A lot of these things will become important for the outlook for 2023 or 2024. But right now, I think it's probably more of the convergence of some of the laggards, that I mentioned, towards more of the leaders across the major economies.
This is so informative. Thank you very much. With the pandemic still being here as a dominant factor for the global macro outlook and new issues such as inflation garnering a lot of attention, what will be the key things for our 2022 investment outlook?
Yeah, I think some of those themes Aurelia will just continue from the outlook for this year. We just cannot give up on the pandemic, right. I mean, you're not going to write this outlook for 2022 until October but I would bet that we will not have stopped talking about the pandemic by then. And we're still very uncertain what will happen over the winter, we know that the summer temperatures in the Northern Hemisphere make a big difference to the pace at which infections can spread.
So we don't know exactly what happens when the temperatures decline again. And infections spread more easily because we're more indoors. And we potentially face more virulent strains of the pandemic, but in a population that has a much higher vaccination rate. So there are a lot of uncertainties here. And then the other uncertainty, of course, is also how will governments react?
If I can just interject this a little bit also, because that's another, I think, fascinating phenomenon that I certainly did not see coming in the way it did, that the stringency with which governments reacted to COVID, it's really not much to do with how many COVID cases there are. We've had a lot of COVID cases in the US. But I would say, our lockdowns here went never as far as the ones in Europe, where they did have a lot of COVID cases, but not as many as we had in the US. But many countries in Asia had far, far fewer COVID cases, but their lockdown measures, to some extent were much harsher than what we've seen in the US.
So again, taking that thinking and looking at the winter, it's too easy to say - well most of us will be vaccinated, there could be an increase in cases but the governments won't care anymore, because we’re through the worst. And I'm not so sure that is true. If I look at governments right now in places like Australia or Singapore, where the case numbers are extremely low compared to Europe and the US but the governments’ still impose very harsh restrictions on economic activity. So that is still a risk that I think we need to keep on our radar screen.
I suspect inflation will not be a big theme for next year. Simply because we're seeing the peaks right now, inflation will probably still be higher next year than it was on average in the previous 10 years, it will be lower than it was in the middle of 2021. And I think that will probably matter more than the level of inflation. So we have 5% inflation in the US right now, we end up averaging something like you know, two and a half or 3% next year, I don't think that's going to be a major theme.
I think what could come back, though, is the issue of politics. We have a number of key elections coming up in the next 18 months, which could lead to very significant changes in policy priorities. And when I talk about my framework where, we are regime switching between macro driven financial markets, but now increasingly policy driven financial markets, it is a policy driven environment and the biggest risk to that is a change in policy priorities. So a change in the priorities of a central bank, or more importantly right now, a change in fiscal policy priorities. And what is the biggest source of such change? It's elections, right.
And we have elections coming up in the next 18 months in Germany, in France and in the US, so three very important markets. There are a bunch of other elections. Japan, for example, is also on that list. But I think those three will be really important for very different reasons interestingly enough. I think in Germany, we could end up with a government that is much more inclined to use more fiscal spending to achieve climate change goals.
The German Government was actually taken to court for signing up to the Paris Climate Change Accord, but then not doing anything about it. So you can actually take a government to court for being inactive, which is interesting. So they may end up spending more money in the future, on this rather new policy priority of preventing the impact of climate change.
In France, we have a probably much starker choice between a more radical anti Euro right wing Government, and possibly the continuation of the current Government, which is not particularly liked. So this could be much more a series of philosophical elections, where are we going here on a grander scheme? Are we continuing to support this project of European integration? Or could there be a risk of not so much a, let's say, Brexit, but an undermining of some of the policy institutions in Europe. So the French elections will have that focus.
And then at the end of next year, we'll have the US midterm elections. And if I listened to the political experts here, it seems quite likely that the Democrats who have a majority right now in both houses of Congress could lose the majority in the House of Representatives, and that basically would shut the door on any more fiscal policy.
So there are a number of elections that could change policy priorities, whether it’s fiscal, as probably the case in the US or Germany, or even more broader in terms of economic policy, that the French elections maybe about that, I think could have very significant consequences for financial markets.
So I think that's one of the themes that I will be focusing on, in addition to more continuous monitoring of the pandemic, the evolution and convergence of growth trends in 2022. But then the major risk sources that may come from those three elections that I mentioned.
Thank you very much Markus for this insight and that fair amount of information. Is there anything that you would still like to add in addition, to what we've covered already?
Yeah, I just want to make sure that, like in our investment outlook that the overall impression doesn't get lost in some of the details, right. Of course, it is never as easy as like one final sentence or one bullet point and obviously, at PineBridge, we do spend a lot of time looking at first of all identifying the key trends and then monitoring and watching those key trends, and it's usually a multitude of trends.
But I do want to make sure that we leave it with the impression, this is still a world where growth rates will be very strong everywhere, I think we're not going to return to the more normal growth rates, we were used to prior to the crisis until 2023, probably 2024 at the earliest.
So this will be still an environment over the next 18 months, where financial markets are poised to continue to do well, in particular, those asset classes that are geared towards growth. And I'm not so concerned that growth forecasts for 2022 will be lower than growth forecasts for 2021. Yes, that's maybe true. But in the US, for example, our growth rate will go from somewhere between six and 7% in 2021, to somewhere between four and 5% in 2022. You could focus on the deceleration aspect of it but I would focus much more on the fact that we are still well above what the economy did in the previous 10 years and what the economy actually really is able to do in the long run.
So the growth environment will still be very strong and that means in our strategies, we will continue to stay exposed to asset classes that benefit from those growth rates, that benefit from accelerated cash flow. And it's way too early to start to look at the transition to a more risk averse allocation.
Thank you very much Markus for this interesting discussion and everyone for listening and we hope you will join us for future episodes of our podcast series. For more economic and investing insights, please visit our website pinebridge.com.