Market report: September – October 2021
Equity markets – a monetarist look
The “monetarist” forecasting technique is based on the assumptions that:
- real narrow money growth leads demand/production growth by 6-12 months (average 9 months) and
- nominal wide money growth leads inflation by 1-3 years (average 2+ years).
Global narrow / broad money growth accelerated in 2020 but has since declined. This slowdown is causing a loss of economic momentum, but the inflationary impact of the 2020 bulge will last until 2022. As a result, current “stagflation” fears are likely to endure.
Chart 1: Global Manufacturing PMI New Orders & G7 + E7 Real Narrow Money (% 6m)
Source: Refinitiv Data Stream
Economic data is being distorted as a result of supply chain disruption, confounding research. The basic assumption is that the global manufacturing PMI new orders index is a reliable indicator of underlying industrial demand dynamics. Since May, the index has declined, matching a previous dip in worldwide (G7 plus E7) six-month real narrow money growth from a July 2020 top – see chart 1. With real money growth slowing further through July/August 2021, the PMI new orders index is unlikely to hit a bottom until early 2022.
However, supply chain disruption has resulted in a significant undershoot of industrial production relative to the growth rate anticipated by the PMI new orders index, signaling the possibility of a short-term catch-up – chart 2. Market players may misinterpret such a surge as a change in trend momentum. Confusion in signals may increase market volatility, but any recovery in the cyclical / reflation trade is likely to be fleeting until monetary trends – and hence PMI prospects – improve.
Chart 2: G7 + E7 Industrial Output (% 6m) & Global Manufacturing PMI New Orders
Source: Refinitiv Data Stream
Reflation or Stagflation
While the timing and final peak remain unknown, we anticipate inflation to slow in the second quarter of 2022 as the base impacts of energy prices fade and temporary variables associated with re-opening dynamics, such as supply-side limitations and the impact of German VAT reforms, fully unwind.
Pricing power. Expectations for higher selling prices to safeguard margins continue to climb, but pricing power appears limited, particularly in the long run and in industries driving current commodities inflation, such as manufacturing (Figure). This begs the question of how the normalization of demand for commodities and the resulting shift back to services would affect inflation. We believe the overall effect will be net deflationary, since services inflation will be more subdued as catch-up benefits fade. Furthermore, there are signs that demand has adjusted to limiting supply, making broad-based price fixing more difficult.
Wage determination. Wage pressures in the Eurozone have been patchy, and the possibility of major second-round impacts looks to be restricted for the time being, given labor market slack is expected to linger for a protracted term. While supporting measures have kept large job losses at bay, labor participation has fallen, artificially lowering the unemployment rate. The progressive withdrawal of policy assistance will re-enter the labor market, notably in the lower-paid service sector, mitigating any impact on wages, particularly in more fragile nations where nominal pay rigidities are more constraining. There may be pockets of inflationary wage price loops in industries with pre-crisis labor shortages (e.g., financial services, health care, and communications technology), as opposed to those with transitory labor shortages (and are likely to unwind as partial unemployment schemes expire).
Figure: short and long term sectoral pricing power.
The most important observations on the condition of the economy in a global perspective
* We increased our global trade prediction for 2021 (+0.3pp to +8.0% in volume and +1.0pp to +16.9% in value). The race to refill amid record large domestic production deficits and low stockpiles has accelerated both volumes and pricing. We anticipate that pricing and capacity challenges would persist through 2022.
* While some emerging markets have begun to tighten policy, advanced economies’ monetary conditions have remained loose. Several central banks in Latin America and Developing Europe have begun to tighten policy by raising interest rates and decreasing asset purchases; nevertheless, other emerging Asian nations have grown even more accommodating. The ECB is expected to be even more patient following strategy changes that saw it embrace a somewhat higher inflation objective. In reaction to a rapidly decreasing production gap and solid employment growth, the US Federal Reserve is likely to begin tapering later this year (and sooner than projected).
* Although financing circumstances remain good, negative risks are increasing. Banks are still generally well-capitalized, with capital buffers that are expected to be substantial enough to absorb loan losses. Because of continuous borrower support and excellent capital conservation policies, they have been able to gradually absorb mounting impairments without significantly changing their capital ratios. However, when support measures expire, deteriorating asset quality may put the sufficiency of present loan-loss provisioning to the test, particularly in countries where private sector debt is high and banks are substantially exposed to hard-hit industries.
* While global GDP growth is predicted to continue high in 2021 and 2022, the rebound will most likely be modest and uneven. Most nations’ output will return to pre-crisis levels, but it will still be below potential by the end of 2022. The cumulative production loss compared to the pre-crisis trend is significant, and it is exacerbated in nations with low vaccination rates.
* Unwinding policy assistance necessitates a delicate balancing act to enable an effective shift toward private demand and long-term growth. Most nations’ fiscal impulses remain positive, with China and the United States anticipated to continue expansionary, while the Eurozone has postponed structural tightening due to supplemental spending in France and Germany. While numerous emerging markets have already begun to tighten their monetary policies, most advanced nations’ central banks have remained accommodating, though normalization is on the horizon. The US Federal Reserve is likely to gradually shift away from its supportive approach, with better inflation and growth indicators indicating that economic slack is dissipating faster than expected. Tapering is anticipated to begin later this year, but the extent and timing are difficult to predict because to unknown virus dynamics and inflation pressures.
* The outlook’s risks are generally balanced, although pandemic-related uncertainty remains significant. Higher vaccination rates, along with a greater release of pent-up demand and a faster-than-expected global recovery, may give a stronger boost for development. Tighter financial conditions or an early removal of policy assistance might hinder the recovery and exacerbate private and public sector vulnerabilities, perhaps leading to cliff-edge consequences in some countries and further severe distributional impacts.
* Price and capacity pressures on global commerce are expected to continue till 2022. The boost to services from reopening has waned, while manpower and material shortages are impacting on industry and construction. Supply chain issues have exacerbated in recent months, resulting in a more evident industrial slowdown this summer, which might amplify negative spillover effects to Emerging Markets.
* Extensive policy assistance has reduced the impact of the epidemic on GDP, but economic slack remains significant, with growth momentum slowing throughout the summer. While significant job losses and bankruptcies were avoided, labor participation fell, and private consumption and investment rebounded only partially.
* The commodities price surge slowed in the third quarter. Following the early-year increase in commodity prices, spurred by expected pent-up demand, inventory accumulation, and supply-chain limitations, we are beginning to observe some trend adjustments.
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The views expressed in this document do not constitute research, are not investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.