On the March 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 strengthening global economy and concerns the rebound could stoke inflation.
The global economic recovery appears to be getting a turbo boost from significant progress on vaccine production, distribution and administration, and prospects for fresh US fiscal stimulus. However, the faster and stronger-than-expected rebound is fueling inflation concerns, leading to a sharp rise in bond yields that has spooked stock markets.
Because both vaccine production and the administration of vaccines is ramping up, there is strong confidence that the reopening of economic activity is likely to accelerate. This, combined with the approval of $1.9 trillion US fiscal stimulus package, should provide a strong boost to the global economic recovery. The US economy is on track to a strong GDP rebound with QMA Portfolio Manager Ed Keon expecting double-digit GDP growth during one of the quarters in 2021 and Ellen Gaske, a senior economist at PGIM Fixed Income, expecting 6% GDP growth for 2021. In Keon's view, the US is likely to enjoy an economic boom analogous to the one in the 1950s or the 1960s.
Gaske agrees with Keon that there is likely to be a sharp further rebound in economic activity, not just in the US but globally. However, Pramerica Italy's Patrizia Bussoli expects the European GDP growth recovery to be slower compared to other developed economies, such as the US, at least in early 2021, given the slower rollout of vaccines. PGIM Japan's CIO Seiji Maruyama expects a solid Japanese GDP rebound the second quarter of 2021 after the Q1 contraction. Given the strong recovery, Gaske expects the US economy to recover to its pre-Covid-19 GDP level in Q2, faster than projected by the International Monetary Fund. Japanese GDP is likely to reach its pre-pandemic level by the end of the year and Europe sometime in 2022.
The fuel for the strong recovery is the unleashing of pent-up demand, with the reopening of economic activity and increase in employment. Further, the US has around $1.5 trillion in excess savings above the normal levels, which should increase further due to the cash payments to households in the proposed $1.9 trillion fiscal package. Given the size of the fiscal stimulus, the big question is whether there will be a fiscal cliff or a fiscal reckoning at some point in the future. Gaske believes the fiscal cliff this time around should be less pronounced, as the stimulus funds are likely to be spent more smoothly and in a drawn-out manner. Some of the stimulus directed at federal, state and local government agencies remains available to be used down the road. Households amassed huge amounts of savings over the past year, with aggregate household savings now at three times the levels they were before the pandemic. These savings are likely to be spent over time, preventing an abrupt fall off in spending.
Inflation Fears and Central Banks' Reassurance
Another round of fiscal stimulus in the US, combined with increasing optimism on the vaccine rollout, are setting the stage for a strong economic rebound, both in the US and globally, fueling inflationary expectations. Price pressures have already been seen in some areas, such as semiconductors, but these pressures are likely to become widespread during the year, further fueling inflation concerns. In Gaske's view, the near-term inflation bounce is likely to linger for some time due to supply shortages, but she expects inflation to settle down to a rate that is a bit below where central banks want it.
With bond yields surging across markets, major central banks are seeking to reassure markets that they will not allow rising rates to stymie the ongoing economic recovery, especially with unemployment remaining elevated. US Federal Reserve Chair Powell, in his semi-annual testimony to Congress, sought to reassure markets, saying the job market has a long way to heal before current inflation fears are justified.
In the Eurozone, where the recovery is lagging, the sharp rise in interest rates at the long end is seen as having a negative effect on financial conditions. Two European Central Bank board members highlighted that high rates are unwarranted at this time and that the ECB stands ready to act if required. However, some of the rise in rates is also seen as a good sign by central bankers, validating that their reflation policies are actually working. However, the speed at which rates are rising is probably what central bankers are watching, as evidenced in recent comments by Fed Governor Lael Brainard. Central bankers are also likely watching whether the higher rates are having an adverse impact on interest-sensitive sectors. Looking beyond the near-term volatility in rates and markets, Gaske expects that while easy monetary policies are likely to continue, central banks are likely to switch from use of quantitative easing as the policy tool to relying more on low interest rate policies.
The Bottom line
The accelerated progress on the vaccine front appears to have set the stage for big changes in the US and global economies, financial markets, and our daily lives. While the global economy is on track for a stronger and faster-than-expected GDP rebound, it has also stoked fears that inflation could rise above levels central banks are comfortable with, which might force them to unwind some of the monetary stimulus. Bond yields have surged, which has the potential to threaten the incipient recovery. Reassurances by the Fed, the ECB and other central banks have failed to ease interest rate concerns.
While the economic backdrop is still favorable for financial markets given the robust recovery underway and accommodative central banks, investors are nervous that inflation could spiral out of control, pushing yields even higher and spooking markets. However, the March CIO call participants expressed optimism that markets are likely to look past the near-term inflation concerns and focus on the positives for stocks and other risk assets.