investment insights
Global Investment Outlook 2021: the year when the COVID crisis ends
Lombard Odier Private Bank
Let us begin our annual outlook with a bold statement: 2021 will be the year when the COVID crisis ends. More precisely, it is now clear that the right set of tools will be available by the middle of next year to definitively control the pandemic. And one lesson of the past months is that when virus-related restrictions are lifted, the economic catch-up can be rapid – as experienced during the third quarter of 2020. The examples of China and other Asian economies are also telling.
For sure, before vaccines are fully deployed, the pandemic will remain a challenge to the outlook. Still, it should prove easier to navigate and less economically damaging than during the first half of 2020. Better knowledge of the virus and of the measures necessary to combat its spread allow for much more targeted restrictions. Also, regional divergences put global demand less at risk of a generalised collapse. Finally, policy support measures are in place and continue to be rescaled, which constitutes a significant safety-net. So, while we do expect growth to remain under some pressure in the final quarter of 2020 and first quarter of 2021, the progress made over the past few months is unlikely to be reversed.
If all goes to plan, a resolution of the pandemic through safe, effective, and widely available vaccines would enable economies to recover lost output after their shutdowns and deep 2020 downturn. The relief should be palpable to the global population, potentially inducing a late spring/early summer rush to return to activities that support those sectors most affected by lockdowns (see chart 1, page 4). And, with loose financial conditions, consumer spending should be lifted by lesser precautionary savings. At the same time, a great amount of fiscal stimulus should continue to buttress the recovery. Our baseline scenario thus sees the US economy return to its pre-crisis output level sometime during the second half of 2021, while the euro area will likely have to wait until early 2022.
Such a rebound in activity should also drive a recovery in inflation, but only to moderate levels (see charts 2 and 3, page 5). Firmer consumer demand and some supply shortages, with inventories having been depleted, should push up price growth. But the large output gap, labour market slack, and subdued private sector credit demand means that this normalisation process on the price front is unlikely to hinder central banks in their interventions. The recent changes to their monetary policy framework, with the adopting of Average Inflation Targeting (AIT), will also allow them to keep rates close to zero even as the unemployment rate continues to move down (see charts 4 and 5, page 5).
An important characteristic of the coming – strong – recovery is how uneven it is likely to be, with some countries and industries moving faster than others. Activity in still-depressed sectors such as food services, travel and accommodation can be expected to return to pre-pandemic levels, helping bring the unemployment rate down further. Still, these sectors, as well as general merchandise, clothing and accessory stores sales (indeed perhaps even grocery store sales), continue to face long-term challenges.
Meanwhile, housing and manufacturing are doing just fine. But it is mainly on the global trade front that we expect to see a sharp rebound (see chart 6, page 5). This improved trade outlook stems not only from the expected recovery from the COVID-19 shock, but also from an improvement in international business conditions once the new US administration takes office. Global demand should support exports, which is also encouraging for the economic outlook, particularly in the manufacturing space. After all, with the goods sector constituting the bulk of trade, manufacturing activity should improve in sync with exports. This is a net positive for trade-sensitive economies, especially in Asia and parts of Europe.
All that being said, our constructive scenario, in which significant hurdles have been and continue to be progressively removed (US elections, Brexit, COVID-19), is not free of risks. First and foremost, lingering uncertainty on vaccines makes for significant downside risk. Safety issues, secondary effects, duration of immunity, potential virus mutation: any of these could result in hopes of a return to normalcy being disappointed. Indeed, our base case rests on a gradual but permanent relaxing of economic restrictions. Were vaccines not to prove the decisive tool in containing the pandemic that we expect, downside risks will be material.
Second, anything that would lead to a higher cost of capital and a tightening of financial conditions should be cautiously monitored. This could prove damaging to the valuation of financial assets, as well as make the financing of debt much more challenging. Financial stress, sharply accelerating inflation or a policy mistake paring stimulus back too soon are key risks to monitor in that respect. Although we remain convinced that authorities will strive to remove support gradually and in a measured way, “taper fears” could emerge during the latter half of 2021 – when the global economy has regained a stronger footing.
Finally, a key problem – only made worse by the pandemic – remains the level of overall debt in the system. But although this will need to be monitored over the long run, interest rates are likely to stay near zero for a number of years, keeping interest payments at historical lows. At this point in time, debt levels can therefore be considered sustainable. In fact, rather than the sheer size of the debt pile, what concerns us more is how it is used. We have high hopes for productive investment targeting innovation, infrastructure and inequalities. Should spending not move in this expected direction, disappointment could be significant.
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