The Big Picture
“But this long-run is a misleading guide to current affairs. In the long-run, we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again”. John Maynard Keynes. And as we know, the long-run is made up of a series of short-runs, and there is always a danger that economists and macro strategists conflate the two. Two behavioural sins follow, which unsurprisingly are not mutually exclusive. The most common, particularly for hedge funds and traders, is the immediacy bias, where the focus is entirely on the short-term, and more significant trends go unnoticed. This behavioural sin is matched by the equally insidious “tunnel vision”, exclusive focus on the long term, or more generously, three or four moves into the future. Admittedly a sin that can ultimately be successful, providing the analysis is correct, but it can lead to wild swings in unrealised P&L and many sleepless nights. It is also easy to let short-term price action interfere will long-term analysis, particularly if you are running stop-loss strategies or quoting Mike Tyson out of context “Everybody has a plan until they get punched in the mouth”.
This economist is fearful of setting himself too easy or too useless a task and certainly doesn’t like the idea of receiving a punch in the mouth, metaphorical or otherwise; however, I believe that the near-term picture is relatively straightforward. Indeed the market consensus is universal in its acclaim of stronger economic growth and faster inflation. The Fed agrees, having raised its growth and inflation forecasts to 6.5% and 2.4% in its latest summary of economic projections. This month, the OECD raised its forecast for global economic growth by a remarkable 3.3% to 6.5%. Consequently, divergence from this strong consensus is a matter of degrees. I believe that growth will be materially stronger than consensus in the US and UK. Growth will eventually come in Europe once it gets control of the vaccination process, but the immediate outlook continues to be what Keynes called the long, dragging conditions of the semi-slump. European manufacturing activity will continue to outperform, but high infection rates and slow immunisation will restrain growth. Europe’s dilatoriness matters for the relative performance of asset prices over the next few months, but it doesn’t alter the global outlook nor the prospect for catch-up growth in the fourth quarter.
In the meantime, the driving force will be the strong performance of the US economy, which is likely to be materially stronger than consensus expectations and reverse the recent slowdown in the US economic surprise index. The New York Fed’s Liberty Street blog has acknowledged that seasonal adjustment will have a material impact, and while statisticians are expected to make manual adjustments to mitigate the effects of this echo effect, but it does suggest that growth will be overstated in the second quarter and understated in the third quarter. This sets an important pattern for the near-term, with financial markets gaining a substantial boost from US consumers investing their stimulus cheques over the next couple of months.
The old aphorism “Sell in May and Go Away” is likely to provide a good indication of timing as the lack of new capital coming into the market suggests that an equity market correction is likely over the summer. However, I expect this to fall short of a bear market, generally defined as a 20% correction. Economic growth will strengthen in the fourth quarter as consumers continue to spend their pent-up savings. European growth will play catch-up. Companies will execute their pent-up investment plans, and investors will anticipate another massive US fiscal package. President Biden presented details of his next mega spending plan on Wednesday amounting to $2.25tr. This plan will be paid in part by higher corporate taxes and income taxes on higher earnings, but there will be a net fiscal stimulus next year, and the shift from those with a high propensity to save to those with a low propensity will amplify the fiscal multipliers for 2022.
Global growth will continue to exceed its long-term average in 2022, and risk asset prices will recover from the summer correction, but as Japan has found out, fiscal stimulus is like being on a treadmill, only the net change in the fiscal impulse contributes to growth and the US fiscal impulse is likely to fade as the year progresses and turn negative in 2023. The timing of this negative fiscal impulse is important because it will coincide with the fading of the pent-up, revenge spending. This slowdown will not just return global growth to its pre-pandemic, sluggish pace; it is likely to be even weaker.
These are not the roaring twenties; they are more likely to be the terrible twenties as the historical post-pandemic rise in precautionary savings adds to the global savings glut, further lowering real interest rates. The Fed will not be able to raise interest rates as planned in 2023. Indeed, I believe that the central bank will reluctantly move to negative rates in 2024 and asset prices will stagnate for the rest of the decade.
However, before all that, in the short-run, there will be two important currency trends. Sentiment towards the €uro has turned bearish this year, and it is down 2.3% in March, its largest fall since July 2019; it has further to correct as capital floods towards faster growing and higher yielding Dollar. The Dollar is likely to gain an additional 5% during the second quarter as its economy powers ahead. Although this appreciation should slow over the summer as weaker asset prices balance higher yields, its strength means that Turkey is unlikely to be the only emerging market currency prone to sudden outflows. Vaccine catch-up and faster European growth will reverse Dollar appreciation in the fourth quarter, helping both commodities and emerging market currencies.
I also believe that the Rmnimbi’s recent peak against the Dollar is temporary. The currency is controlled by the Chinese authorities, who have tightened credit in response to the massive US fiscal stimulus. The Chinese savings rate hit 34% last year, and the US trade deficit hit a record even before the deployment of the Biden stimulus. The trade and current account deficits will widen substantially over the summer, which in turn will return currencies to the forefront of the emerging Cold War between the US and China. The Renminbi is going higher. The question is whether the Chinese authorities chose to blunt America anger by allowing further appreciation over the summer or await US censure in the US Treasury’s currency report in the Autumn.
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