On the July PGIM Global Partners CIO call hosted by QMA, chief investment officers and senior investment professionals from PGIM's international businesses, PGIM Fixed Income and QMA discussed the outlook for global growth, the inflation debate and the prospects for global financial markets.
With the global economy on a sound footing and after solid double-digit gains by global equity markets in the first half of 2021, the July CIO Call participants discussed the trajectory of global growth, the risks to growth from the "Delta" variant of the COVID-19 virus, and the outlook for financial markets for the second half of the year. While stock markets remain supported by broadening global growth and robust earnings outlook, there are a number of risks, including the spread of the COVID-19 Delta variant, growth deceleration, inflation uncertainty and policy inflection that are likely to keep markets volatile. Acknowledging these risks, the July call participants called for caution in the near-term.
Economic Outlook: Looking Beyond Peak Growth?
Global growth remains strong with JP Morgan's global GDP Nowcast tracking 4.6% annualized growth for the global economy in Q2, after 4.0% growth in Q1. The US is expected to post its peak growth rate in Q2, while other developed and emerging economies are expected to peak in the second half of 2021. However, beyond the current strong growth rates, there are questions about the growth trajectory as the transfer payments to households runs out, pent-up demand is largely spent, and the Delta variant raises the specter of renewed lockdowns and restrictions on economic activity.
The US economy is firing on all cylinders with Q2 GDP growth tracking around 10% annualized, 13% year-over-year, after 6.4% growth in Q1. While recent data on employment has been favorable, supply constraints have held back vehicle sales, which slowed to 15.36 million in June from 16.99 million in May. Business confidence has also softened from recent highs, but consumer confidence remains strong. Looking ahead, US GDP growth is expected to remain strong with around 7% expected for Q3 and 5% in Q4. The reopening of the economy and the strong consumer has created conditions favorable for a surge in services spending. Meanwhile, the US Congress continues to debate an infrastructure bill, which could provide fiscal support for the economy in the coming years. The June International Monetary Fund (IMF) report on the US economy sees strong 7% growth in 2021 with solid growth (around 5%) continuing into 2022. The unprecedented fiscal and monetary support, combined with high vaccination rate and receding COVID-19 case numbers, should provide a substantial boost to activity in the coming months as savings will be drawn down, demand will return for in-person services, and depleted inventories will be rebuilt.
Eurozone GDP is expected to rebound 5.6% annualized in Q2 as countries began to remove COVID-19 restrictions after a technical recession in Q4 2020 to Q1 2021. Eurozone economies are catching up to the US and UK in vaccine administration, which has helped push down case and fatality rates, though the Delta variant remains a new risk. New COVID-19 cases have come down since April, allowing governments to gradually ease restrictions across countries. The reopening has had a positive impact on labor markets. Looking ahead, Eurozone growth is expected to accelerate to around 9.2% in Q3 before moderating slightly to around 5.2% in Q4.
Japanese GDP is expected to recover modestly in Q2 after contracting (-3.9% annualized) in Q1. Growth momentum decelerated due to the State of Emergency (SoE) imposed in early Q2 to stop the spread of the virus. While the SoE ended on June 11, it was replaced by a partial extension of some measures in various regions, including Tokyo. Further, some cities are expected to continue to be under partial SoE during the Olympic games in late July. Due to the restrictions on activity, Japan's GDP is on track to modest growth of 1% in Q2 but strengthen to over 4% growth in the second half of 2021, supported by the Tokyo Olympics, increased vaccination, and stronger global demand.
Emerging markets continue to see significant divergence in growth trajectories. China has recovered strongly from the lows of the pandemic as it was very successful at containing the spread of the virus and the first to exit lockdown. The Chinese economy is expected to have grown around 8% in Q2, slowing from 18% year-over-year in Q1. Similarly, Taiwan and Korea have recovered strongly on the back of strong export growth and successful containment of the virus. In the rest of Asia, the recovery has been delayed as a surge in COVID-19 cases lead to extensions/new restrictions on economic activity. India's growth suffered a setback with the surge in COVID-19 infections. However, the economy is expected to post a very strong rebound with almost 20% growth in Q2 due to base effects, the lifting of lockdowns in many states, vaccinations rates picking up, and a better than expected monsoon season. Meanwhile, the strength in oil and commodity prices driven by rising demand should benefit the commodity-export-dependent economies of Latin America and EMEA. Commodity exporters, such as South Africa, Chile and Saudi Arabia, are set to outperform their peers. Growth in Q2 is expected to be especially strong in Russia (9%) and Brazil (+12.6%).
Inflation Debate: Jury Still Out but Are Prices Coming off the Boil?
The inflation debate—"transitory versus persistent"—continues, but there appears to be some easing of inflation concerns. The price action in commodities, such as lumber, which saw a steep 40% decline in June after soaring in Q1, suggests a weakening of pandemic-driven booms in some sectors. However, supply chain issues, especially those arising from the semiconductor supply chain, are expected to linger into next year. Meanwhile, OPEC+ failed to reach an agreement on the supply expansion, which has resulted in WTI crude prices rising above $75 per barrel, the highest level since November 2014.
US headline inflation strengthened further to 5% year-over-year in May from 4.2% in April and 2.6% in March with a small number of pandemic-affected categories, like airline fares and car prices, driving the bulk of the price increase. The IMF expects US inflation expectations to remain well-anchored but acknowledged that underlying inflation trends are likely to be obscured in the coming months by significant, transitory movements in prices, resulting in core PCE inflation to temporarily peak around 4%. Once these temporary price surges have passed, the IMF forecasts PCE inflation to stabilize around 2.50% by late 2022. Eurozone inflation eased slightly to 1.9% year-over-year in June from 2% in May, largely due to core inflation easing to 0.9% from 1% previously and energy inflation base effects. In Japan, nationwide inflation increased to -0.1% year-over-year in May from -0.4% in April, while core inflation remained unchanged at -0.2%.
Higher frequency data on trends in inflation from State Street (PriceStats) suggests that price pressures are moderating a bit at least in the US after surging in previous months. US PriceStats inflation peaked at the end of May and has been easing since then to 3.80% year-over-year currently from 4%, while the Canadian series reached its year-on-year high earlier still. However, the measures in the Eurozone and the UK are still in an uptrend. In Emerging Markets, the PriceStats inflation measure has flattened in the past several weeks to around 13.50%.
Policy Backdrop: Still Supportive but Reaching an Inflection Point?
Developed central banks continue to maintain their accommodative stance given their view that the recent surge in inflation is driven by the unleashing of pent-up demand and supply bottle necks and, thus, should prove to be transitory. While it is still too early for developed central banks to think about slamming on the brakes by raising interest rates, they are now tiptoeing towards moving the foot off the accelerator by beginning to taper QE after increasing their balance sheets by nearly $10 trillion since the pandemic began.
At its mid-June meeting, the US Federal Reserve changed its tone and started "talking about tapering" its QE buying, while the median forecast for the start of rate normalization was moved forward to 2023 from an earlier forecast of 2024. The European Central Bank (ECB) left policy rates and its asset purchase program unchanged at its June meeting. The bank raised forecasts for GDP and inflation, noting that "business and consumer surveys and high-frequency indicators point to a sizeable improvement in activity in the second quarter of this year." However, the ECB continues its highly accommodative policies and decided to maintain its PEPP purchases at the "significantly" faster pace seen over the past three months to avoid a hawkish surprise to markets." In addition, it remains relatively sanguine about rising inflation, noting that energy prices have been the major driver of the increase in the forecasts. The Bank of Japan left policy rates unchanged at its June meeting but is expected to maintain the current monetary policy.
Among Emerging Markets, there is a split between central banks starting to renormalize policy and others still grappling with virus-related downside risks to activity. In China, tightening of credit and housing policies already are underway. Brazil's and Russia's central banks have raised rates by 75 basis points each. Rates remain on hold in Korea and Taiwan, while in India, the Reserve Bank of India continues to maintain an accommodative stance "to mitigate the impact of COVID-19 on the economy" and continues bond buying.
The Bottom Line
Following the strong gains in the first half of 2021, the July CIO Call participants called for a dose of caution despite the generally positive outlook for the global economy and equity markets. The global economy is now on solid footing with GDP growth broadening as widespread vaccine administration is unleashing pent up demand. US growth is likely to peak in Q2 and other developed and emerging economies are expected to peak in the second half of 2021. However, there are concerns about the growth trajectory beyond today's solid growth as transfer payments to households begin to run out and pent-up demand is largely spent. Further, while vaccine administration has improved, the spread of the Delta variant is raising the specter of renewed lockdowns and restrictions on economic activity. After the inflation scare in Q2, there are signs that inflation is coming off the boil. However, the jury is still out on whether the current surge in inflation is "transitory" or more "persistent." Consequently, there is increased uncertainty about the future course of monetary policy and whether we are close to an inflection point. While developed central banks continue to maintain their accommodative stance (and it may be a long time before they slam the brakes), they may be closer to removing the foot from the accelerator and starting QE tapering. This carries the risk of another “taper tantrum” no matter how well central banks choreograph their intentions. Thus, while stock markets remain supported by broadening global growth and robust earnings results, the near-term outlook is clouded by fresh risks from the Delta variant, concerns about a growth slowdown, inflation uncertainty and the potential end of the ultra-easy monetary policy regime. Acknowledging these risks, the July CIO call participants called for caution in the near-term.