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This quarter, we focus on how regional differences in COVID vaccination rates, government policy goals, and the ensuing trade-offs have led to three distinct ”blocks” of the global economy. In our view, investors should track the dynamics of each ”block” separately in order to successfully navigate this phase of the global economic recovery.
From one speed to three
The depth and universality of the COVID shock, along with the massive global policy responses to it, have driven most economic and market behavior over the past year. This year, the advent of effective vaccines, combined with better COVID testing and treatment methods, has provided hope that life (and with it, the global economy) can begin the long journey toward full “normalization.”
This initial period of vaccine-led reopenings, together with substantial policy stimulus, has delivered strong economic growth and a broad reflationary trade that has been playing out across global markets. Interest rates (and inflation) have risen, yield curves have steepened, and cyclical assets have generally outperformed their more defensive counterparts. However, as we warned late last year, this normalization period is likely to be marked by growing divergences across regions, countries, markets, and sectors. With 2021 roughly half over as of this writing, we are now able to better discern those divergences and their underlying causes.
Specifically, around the world, it is becoming clear that many individual countries now differ widely from one another with regard to:
- COVID vaccine provision, with some countries nearing so-called ”herd immunity,” while others have yet to really begin the process of vaccinating their populations;
- Their acceptable trade-off between economic mobility and public health, with some countries still locked down at peak COVID levels and others quite far along the reopening path; and
- Different policy priorities, with some focused on generating economic growth through stimulatory policy and others having prioritized stability and structural reforms over growth.
The upshot, as we see it, is that the world can now be broadly (and imperfectly) bucketed into three main groups, each moving at very different speeds and via very different catalysts: 1) the ”boosters”; 2) the COVID “racers”; and 3) the ”reformers.” Each of these three groups is likely to be beholden to very different dynamics over the next few quarters. All three will also impact the markets to varying degrees and with varying effects.
Block 1: The ”boosters”
The countries in this first group have made significant progress on vaccine provision, which has generally allowed them to pivot to favoring the resumption of economic mobility over once-heightened public-health concerns (Figure 1). Their policy stances are now more focused on stimulating their economies, despite (and in addition to) strong private-sector demand. Their largely successful vaccine rollouts have increasingly transformed COVID into a manageable public-health issue, while ultra-loose public spending has joined with pent-up private-sector spending and constrained supply curves to help boost growth and inflation even higher.
The US is the obvious cornerstone of this block, but other countries (such as the UK and much of continental Europe) are not far behind. In terms of the outlook, what matters most for this group over the next few quarters will be the ongoing interactions among growth, inflation, and policy. Loose policy is driving growth and inflation higher, but if growth and inflation rise too much, policy will likely need to become tighter, dampening both growth and inflation. Indeed, this group is emerging from the COVID shock so fast that attention is already turning to when, and how, their policy stances will be able to shift from accommodative to more hawkish (including “tapering” of asset purchases undertaken amid the pandemic).
Adding to this dynamic is the role of tighter and more sensitive labor markets in generating higher inflation. Many of these countries have seen reductions in their labor forces due to early retirements (asset bases are higher) and lower immigration rates (including Brexit’s impact on the UK). The result has been…
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