By Chetan Ahya, Morgan Stanley’s Chief Economist and Global Head of Economics
Nearly a year ago, we wrote in the Sunday Start about the first growth scare of the new cycle (see Three Reasons Why the Recovery Is on Track, July 26, 2020). Then, a rise in COVID-19 cases sparked fears of renewed lockdowns, and the delay in passing additional fiscal stimulus in the US led to concerns that the consumption recovery would sputter.
Today, we are facing another growth scare. Just like the last time, we see good reasons why these fears will fade.
#1 – The virus/economy equation continues to evolve
The more transmissible Delta variant is leading to a renewed rise in cases, particularly among unvaccinated populations. Encouragingly, while case counts are rising, all indications are that existing vaccines are still highly effective in preventing severe illness and, more importantly, hospitalisations.
Hence, for economies with relatively high vaccination rates, like the US, UK and euro area, we don’t expect hospital system capacity to be overwhelmed and thus see a low probability of strict lockdowns returning. For economies which are lagging in their vaccination efforts, for instance parts of Asia, the risk is that variants will delay a full relaxation of restrictions. While the recovery in external demand and capex is advancing for these economies, we see domestic consumption being held back over the next 3-4 months. However, vaccinations are expected to pick up, which would give policy-makers greater flexibility to reopen their economies, setting the stage for a broad-based recovery to take hold late this year.
#2 – US: Withdrawal of policy support is not as premature as you think
As recoveries progress and economies move towards a self-sustaining path, it is only natural for policy-makers to start thinking about exit strategies. However, we believe that neither fiscal nor monetary policy support will be removed at a faster pace than warranted.
The US economy is already on a strong footing. Wage incomes stand at 105% of pre-COVID-19 levels, real investment is already 4% higher and GDP has reached its pre-COVID-19 path.
While the fiscal impulse is turning negative this year, its impact on growth has been overstated. That’s because fiscal measures have largely taken the form of transfers to households. In fact, the excess transfers are still sitting on household balance sheets, waiting to be spent. US households have accumulated US$2.3 trillion in excess saving, and our strong US GDP growth forecasts of 7.1%Y for 2021 and 4.9%Y for 2022 don’t assume that this stock will have to be drawn down.
As regards the Fed, our chief US economist Ellen Zentner continues to expect forward guidance in September and an official announcement of tapering in March, with the risks skewed towards an earlier start. By the time tapering starts, we forecast that the US economy will be well above its pre-COVID-19 path, core PCE inflation will exceed 2%Y sustainably (adjusted for base effects and transitory factors) and U-6 unemployment (the broadest measure) will reach ~8.5% (versus a pre-pandemic low of 7%) as compared to 13% during the time of tapering in December 2013 – hardly conditions that indicate the withdrawal of accommodation is premature.
#3 – China: From tightening to modest easing
While growth is usually sustained by external demand and capex during periods of counter-cyclical tightening, COVID-19 flare-ups have hampered the private consumption recovery in this cycle. Accordingly, policy-makers are beginning to fine-tune their policy stance to offset the effects of the resulting small growth downside. Our chief China economist Robin Xing expects modest fiscal easing, complemented by liquidity injection and the cut in the reserve requirement ratio on July 9. We remain confident that China’s GDP will grow by 8.7%Y this year.
#4 – Supply-side constraints are transitory
Supply-side constraints continue to be reflected in the sub-indices of the manufacturing PMIs – supplier delivery times and inventories. What’s more, these obstacles have dampened production, with a shortage of chips crimping auto production and leading to downside surprises in Japan and Korea’s industrial production growth. Similarly, labour shortages have hampered services sector growth, especially in the US, where labour participation has been held back in part because generous unemployment benefits are still in effect in some states and schools have yet to fully resume in-person learning. However, we expect labour supply conditions to improve over the next 3-4 months, enabling production to ramp up and inventories to return to more normalised levels, providing a strong boost to GDP growth.
Overall, we see this growth scare as just that – a scare. Indeed, while there have been some downside growth surprises in economies like China and India, they have been offset by upside surprises in Europe and Latin America, keeping our global growth forecasts unchanged (at 6.5%Y for 2021 and 4.9%Y for 2022) since we published our mid-year outlook. More fundamentally, the outlook for demand is strong, and we remain convinced that the unfolding of a red-hot capex cycle will sustain global GDP above its pre-COVID-19 path from this quarter on through to end-2022.