The recovery from the coronavirus crisis is on its way, and we expect high growth rates in all major economies in 2021 and 2022. The rapid recovery will intensify price pressures, which have already received a boost from rising raw material prices and bottlenecks in supply chains. Higher inflation rates are expected, especially in the US where the Fed is expected to start hiking rates next year. Higher growth and rate prospects in the US are expected to benefit the dollar.
We continue to expect that the recovery after the coronavirus crisis will be strong and take most economies’ growth numbers high both in 2021 and 2022. All the factors we listed in the January issue of Economic Outlook that boost the recovery continue to exist: immense fiscal and monetary support, pent-up demand and a high excess household savings. We also continue to expect that the services sector rebound will lead to a fast labour market recovery, unlike after a typical financial crisis where the reallocation of resources takes a lot of time.
However, there are vast differences among the countries when it comes to the exact timing and strength of the recovery. As vaccinations are concentrated in the developed economies, it is also clear that those countries will be much faster to remove the restrictions and to recover. Thus, while the US and the UK are already reopening their economies and most Euro-area countries are expected to follow suit in the coming weeks and months, many emerging economies are likely to continue to suffer from the coronavirus crisis in the beginning of 2022.
The biggest downside risk to our rather optimistic view is that something goes wrong in the fight against the virus and, for example, new mutations resistant to vaccines keep emerging. That could lead to weaker confidence among both households and companies as well as a delayed and weaker recovery.
US takes the lead in the West
Optimism is on the rise in the US as the economy reopens and the population approaches herd immunity. Three rounds of stimulus checks, coupled with generous unemployment benefits, have led to strong household balance sheets and income levels in aggregate, which will facilitate a surge in consumer spending. Up to three quarters of the checks have been saved or used to pay down debt, and consumers are thus ready to kick-start the recovery as restrictions are lifted. This should lead to a rapid recovery also in the labour market, causing a positive circle. However, given that expectations for the US economy are now really high, there is a risk that the spending surge might falter more quickly than expected as the distribution of savings is skewed towards higher income brackets.
GDP growth forecast, % Y/Y
The Euro area is in a rush to save another high season in tourism.
Tuuli Koivu, Nordea Chief Economist
China already in tightening mode
China’s recovery is so well on track that its leaders are shifting their focus from the pandemic towards the long-term challenges of the economy. One of those challenges is the high level of debt, which is expected to be tackled by a gradually tighter policy stance this year. On the other hand, China is well-known for its very targeted measures and we expect that also this time, for instance, the real estate sector will cool off while some manufacturing sectors will continue to enjoy favourable conditions required to fulfil the leaders’ target to double GDP by 2035.
Euro area: contre-la-montre
Although the pace of the recovery in the Euro area will be somewhat slower than in the US, we stick to our view that the economy as a whole should be close to the pre-crisis level at the end of 2021. At the moment, the Euro area is in a rush to save another high season in tourism, which is extremely important for the southern European countries. We continue to believe that, together with the seasonal variation of the virus, the pace of vaccinations will be sufficient to open up cross-border travelling within Europe in July. However, for that to happen, there should be no further setbacks on the vaccine front.
After very low inflation in most developed economies in 2020, inflation numbers have recently recovered, mostly due to the rebound in energy prices and faltering deflationary pressures in the services industry. The rise in producer prices has been even bigger due to a high share of raw material prices and the faster-than-expected recovery in manufacturing, which has led to many bottlenecks and price increases in global supply chains. However, much more than that is needed in order to see a significant and permanent rise in consumer price inflation. For that purpose, the exceptional amount of fiscal and monetary easing and the expected fast recovery especially in the US provides, of course, an interesting environment, and we have already seen higher inflation expectations both in the financial markets and in survey-based indicators. Thus, although the Fed has remained calm in its comments on inflation, the risk of considerably higher inflation clearly exists in the US. In the Euro area, inflation numbers are expected to be volatile in the near term but the million-dollar question is whether the weak link from the real economy to inflation that prevailed prior to the pandemic will return when the recovery gains speed and the slack in the economy declines.
Bond purchases not preventing higher yields
While major central banks are pledging not to reverse course any time soon, the Fed could find itself debating tapering its bond purchases already during the summer. The ECB will probably be slower in scaling down its purchases, but its appetite for large-scale purchases appears to be waning, and the pandemic-era bond purchase programme is set to be concluded in March 2022. While the ECB is likely to continue to buy bonds under its other bond purchase programmes after March 2022, the volumes will be much smaller. The lesson from history is that bond yields can, and often do, climb in times of even large central bank bond purchases.
In response to the booming economy, we expect the Fed to start raising rates already next year, which means that the short end of the curve may not stay anchored for that much longer. Longer yields have already risen from their lows and will continue to climb going forward. Almost no matter which macro-related bond yield model one uses, the conclusion is the same: long rates remain much lower than the macro outlook suggests. The deviations from macro-implied levels and the upside potential look much larger for US yields compared to Euro-area yields.
While our baseline is for even US yields to remain at historically low levels throughout the forecast horizon, risks are tilted to the upside, as the inflation risks in the US economy are genuine, and massive economic growth could easily drive yields higher at a faster rate than we assume in our baseline scenario.
FX: USD to return to stronger levels
The USD has weakened materially over the past 9-12 months, which has been driven by mass money printing by the Federal Reserve not least in Q2 2020. The USD usually also weakens when the global economy rebounds in tandem, which is what we have seen in recent quarters. The US is now about to reap the growth rewards of the experimental policy mix of massive money printing and large-scale fiscal stimulus.
The US is likely to outperform all peers growth-wise this year, which over time usually leads to a stronger USD versus other currencies as a result of the side effects of a stronger growth pace. First, USD bonds may continue to yield better than most peers; second, the Fed is more likely to respond to strong growth rates via a slightly tighter policy, maybe via a tapering discussion already this summer.
Our view on USD interest rates could also lead to a reversal of the EUR/USD cross towards the second half of this year. We find it likely that EUR/USD will end 2021 at clearly lower levels compared to the current spot level as USD interest rates are simply more alive than EUR dittos, not least because the ECB seemingly wants to keep printing to support the economic rebound during the spring and early summer. The fixed income market also reflects relative growth perspectives, which simply look more upbeat in the US compared to Europe, among other things due to a more successful vaccine rollout. We target 1.15-1.16 for EUR/USD.
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