Diverging recoveries, diverging policies

Kerry Craig

J.P. Morgan Asset Management

Variations in vaccination progress and economic stimulus have delayed synchronization of the global economic recovery. The U.S. is expected to lead the recovery in 2021, and Europe should follow. China’s economy has normalized and is expected to expand along its trend growth.

Global inflation has accelerated as expected, but there is little clarity whether a series of one-off factors, such as supply-side bottlenecks, semiconductor shortages and commodity price volatility, could prolong this trend.

Desynchronised recovery implies diverging paths for global monetary policy. Some smaller central banks have already become more hawkish. China has started to normalize with slower credit growth, and the U.S. is still being patient, despite a pick up in inflation. Meanwhile, the priority of most Asian central banks is to get through the latest wave of infections.

Uneven global recovery

The next phase of recovery should be determined by the progress of vaccinations, which in turn will boost consumption and business investment.

The U.S. and the UK have been the leading major economies in vaccinations. China and Europe have also accelerated the pace of inoculating their populations. However, Asia and other emerging markets are lagging due to vaccine hesitancy and insufficient supply.

Locations with better progress on vaccinations can re-open their economies on a more consistent basis, attracting consumption and business investments. This is already happening in the U.S., alongside sizeable fiscal stimulus.

For the laggards, the recovery will likely be delayed until 2022 or beyond. For Asia, the export outlook is still favorable, but domestic demand and travel will stay subdued for much of 2021.

Inflation is driven by a series of one-off events

Global inflation has accelerated as expected. But a few one-off factors in the U.S. are driving prices higher.

The U.S. labor market distortion could push up wages in the near term. Businesses are struggling to hire despite the unemployment rate still being high. But the situation may ease in 3Q 2021 as supplemental unemployment support ends.

Nonetheless, supply-side bottlenecks, such as rising shipping costs, could continue to assert pressure on prices. A shortage in semiconductors and fuel could also prolong elevated inflation in the coming months.

We still expect U.S. inflation to revert to the Fed’s 2% long-term target in 2022. However, investors will remain focused on whether more one-off events would delay the return to normality, and whether the Fed would be pressured to raise rates earlier than expected.

Central banks are going their separate ways

The varying pace of recovery could prompt global central banks to adopt different strategies in normalizing their monetary policies.

The Fed is still a kingpin given its influence in global markets. We expect the Fed’s asset purchases to slow in early 2022, and it may need to advance the first rate hike to 2023, or even sooner to 2022, should the inflation momentum persist and the unemployment rate continue to fall.

The People’s Bank of China has already pared back credit growth in the first several months of 2021, with an emphasis on constraining corporate leverage and the real estate market.

Investment implications

The economic recovery should continue to be positive for risk assets. However, the varying pace of the recovery implies Asian investors should take a more active approach when allocating by region.

The U.S. and China are still leading in terms of economic performance, even though the strongest period of their rebound has probably passed. Europe is starting to benefit from a higher vaccination rate and the implementation of the European Recovery Fund.

Asia’s domestic demand is still challenged by further waves of infections, but its export sector is posting strong demand.

Ongoing inflation worries and future policy normalization could push bond yields higher, which require fixed income investors to be agile. Yet, higher inflation would raise demand for income and could push investors to other income-generating assets such as high-dividend stocks and alternatives, alongside high yield (HY) debt and emerging market (EM) bonds.

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Kerry Craig
Global Market Strategist.
J.P. Morgan Asset Management

Kerry Craig, Executive Director, is a Global Market Strategist. Based in Melbourne, Kerry is responsible for communicating the latest market and economic views from our Global Market Insights Strategy Team.

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