13 October 2021

Global overview

Big picture

Since writing about peak macro in the last edition of Global Macro Outlook, global economic data has presented—as expected—upside surprises on inflation with downside surprises on growth. 

Over the summer, we saw mounting evidence that supply chain disruptions were hampering growth activity and that stagflationary dynamics were at play; however, we continue to believe that inflation will moderate in 2022 and global growth will remain relatively elevated, particularly in the United States. 

As we approach Q4, we believe that the worst of the stagflationary concerns have mostly been priced into the markets as upside surprises to inflation moderate and downside surprises to growth should ease. 

To be clear, this has less to do with these stagflationary pressures actually moderating and more to do with the (improved) alignment of market expectations with what’s really happening. We believe this to be particularly true for the United States and Europe. In our view, the market narrative will now likely shift away from stagflation to what we call a fragile and transitory Goldilocks base case in Q4.  

In terms of monetary policy, while the current environment might feel a little more hawkish relative to even just a couple of months ago, we expect central banks will adopt a more dovish stance heading into year end, particularly in 2022.

A transitory Goldilocks narrative

Broadly speaking, the main macro drivers that point us in the direction of a fragile Goldilocks narrative are:

• Recalibrating expectations—We expect to see a recalibration of investor expectations that should bring market consensus closer to the growth outlook for the year ahead. In other words, the market consensus should reflect a more favorable mix of growth and inflation relative to what’s already been priced by the market. While this is pretty far from the reflation trade environment that we experienced from March 2020 to May 2021, we believe it’s an environment that’s still generally positive for risk assets. 
  
• A slower, unsynchronized, recovery that reduces the tail risk of a boom-bust scenario in 2022—Downgrades to the 2021 growth outlook could ironically mean potentially more support for 2022 (or, at least, we believe that’s how the market will see it). 
  
• Inventory rebuild—A widely expected global inventory rebuild in the coming year is likely to support capex growth. After a protracted period of disruption, we should see pockets of improvements in some key parts of the supply chains. U.S. housing, for instance, should contribute to improving the growth picture.
  
• Moving past peak COVID-19—We believe the number of infections globally could begin to trend lower soon, notably in Asia. This could lend some support to global growth.
  
• The resilient U.S. consumer—U.S. retail spending has held up despite weak consumer confidence.
  
• A U.S. labor market that appears to be healing—Although the shortage in workers has been a source of frustration for many businesses, aggregate measures of wage growth remain muted. We expect concerns about labor supply to gradually ease in the autumn months, which should add to the perception of an improving growth outlook—specifically, one with limited inflationary pressures.
  

Introducing the three bears

We believe that the key downside risks confronting markets can be categorized into three buckets, which we call the three bears, any of which could put an end to the fragile fairy tale pretty quickly—not least because we’re already in mid- to late cycle and have also likely seen peak earnings expectations. Put differently, this is not the time for big bets. We could find ourselves back in the stagflationary regime, or a more problematic stagnation regime (declining growth and declining inflation), without warning. 

Bear one: potential monetary/fiscal policy mistakes 

Monetary policy—Global central banks are sounding more hawkish—U-turns from the Bank of England (BoE), policy adjustments from the European Central Bank (ECB), a Bank of Canada (BoC) that’s actively tapering, and a U.S. Federal Reserve (Fed) that’s set on winding down its asset purchase program. 

Fiscal policy—Global fiscal policy is also in tightening mode, and we believe we’re well past the point of peak fiscal support, especially in Asia and Europe. The picture isn’t too different in the United States. Heading into year end, we believe there’s ample room for headline risk related to a smaller-than-expected bipartisan infrastructure bill, potential corporate tax increases, and the growing likelihood of being faced with another debt ceiling—all of which would have an impact on the global growth outlook.

Bear two: the Delta variant and stagflation/supply shocks

While we believe the market is far more aware and sensitive to the risk of stagflationary developments (i.e., rising prices that could erode growth) than before, it still represents a material risk to global growth dynamics—particularly as major economies continue to shutter ports and place a cap on economic activity in pursuit of a zero-COVID-19 strategy. More than ever, investors should pay attention to developments on the supply side.

Bear three: China

In our view, the downside risks in the coming quarter are most concentrated in China, where the delayed effects of policy tightening (credit, monetary, fiscal, regulatory) are likely to continue to weigh on growth, perhaps a little more than expected or had been intended. We also expect broader regulatory clampdowns to persist through 2022. Unsurprisingly, investor sentiment toward China remains negative. Crucially, we believe China isn’t well positioned to tackle risks associated with a stagflationary environment.