The Q2 global economic outlook: rational exuberance is driving great expectations

14 April 2021

Michelle GirardManaging Director, Co-Head Global Economics, Head of Strategic Coordination & Business Operations, US

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Ross WalkerChief UK Economist

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Sam BoughtonDirector, Corporate Syndicate, NatWest Markets

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We expect a consumer-led recovery stoked by accommodative fiscal & monetary policy to propel the global economy further than many expect, but risks abound for corporate & institutional decision-makers. In this deep dive, our specialists outline four key calls driving the global economic outlook and risk landscape in Q2.

Key calls:  

  • We expect global gross domestic product (GDP) to advance by 6.6% in 2021 and 5.9% in 2022 – which is more optimistic than most.
  • Developed economies should outperform, led by the US – in contrast to our view late last year.
  • Savings reached new heights during the pandemic, and we forecast 15-20% of the newly accumulated “forced” savings stock to be spent over the next year as restrictions ease.

A year of restrictions on economic activity is about to give way to an exuberant consumer-led recovery in Q2 and for the remainder of 2021. We see the risks for domestic demand and GDP skewed firmly to the upside in 2021 compared with official forecasts: as the table below shows, we now expect global GDP to advance by 6.6% in 2021 and 5.9% in 2022, around 1-1.5% above even the most recent upwardly revised forecasts from the likes of the International Monetary Fund (IMF) and other multilateral agencies.

We are more optimistic than most on global growth (% year-on-year)

Sources: NatWest Markets, IMF, World Bank, Bloomberg, OECD

Strong consumption & large fiscal transfers will drive significant rebounds

Sources: NatWest Markets 2021 Q1 – 2021 Q4 = forecast. *Our global growth aggregate includes 18 countries together accounting for 82% of global growth: UK, US, Euro Area, China, Japan, Australia, Brazil, Canada, India, Mexico, Norway, Poland, Russia, Singapore, South Africa, South Korea, Sweden, and Turkey.

Developed economies should outperform, led by the US. This will be driven by a fruitful combination of high pent-up savings, strong vaccination progress, easing of pandemic-related restrictions and of course, sizeable fiscal stimulus – particularly in the US, where the government recently approved a $1.9 trillion stimulus package and will put forward another $2 trillion of infrastructure spending. Weak consumption in 2020 and large fiscal injections in both countries (and in some Euro Area countries) have resulted in the accumulation of historically high savings (see chart below), which we expect will fuel significant rebounds in consumer spending. In the US, household disposable income growth has seen a near 10% rise and modest gains in the UK and Euro Area, thanks mainly to large fiscal transfers & state support.

What a save: lockdowns push household savings to new heights (%)

Sources: US Bureau of Economic Analysis (US BEA), Eurostat, UK Office for National Statistics (ONS)

The extent to which forced savings – excess savings that aren’t precautionary – are drawn down in 2021 will determine the scale of the rebound. The savings stock has climbed to 17% in the US, 20% in the Euro Area and 11% in the UK – perhaps the most extraordinary save since Gordon Banks denied Pele a headed goal in the 1970 World Cup.

We estimate some 15-20% of forced savings will be spent over the next year or so – significantly higher than some policymakers believe. In the UK, for instance, the Bank of England (BOE), is forecasting around 5%. Although these savings are unevenly distributed across different income cohorts (which will affect what people buy and where price pressures emerge), the debate is less about the extent to which the money is there and more about the rate at which it will be spent. But even without a run-down of these savings, income and expenditure flows suggest a sizeable upward shift in consumption. By the end of 2021, we expect saving ratios in the Euro Area and UK to be within a percentage point of pre-crisis levels (Q4 2019).

Key calls:

  • Huge US fiscal stimulus will drive inflation divergence across G3 regions – we think US core inflation will approach 2.5% by the end of 2022, the strongest performance since 2007.
  • Rising UK and Euro Area inflation will mainly be temporary in nature.
  • We may still see a pronounced shift in central bank rhetoric, not necessarily changes to policy rates – but expect bond yields to continue to rise.

With savings at multi-decade highs and many large economies flush with stimulus cash, we expect a consumption-led economic rebound coupled with rising inflation – led by the US. With materially stronger projections for income growth in the US in 2021 (in relative terms), a larger fiscal stimulus and the Fed having adopted a more dovish policy framework, we expect US inflation to rise moderately during most of 2021 and 2022.

Inflation: what goes up, in most cases, comes down (% year-on-year)

Sources: US BEA, Eurostat, UK ONS, NatWest Markets

In the Euro Area and UK, we tend to view some of the rise in inflation in 2021 as more temporary, stemming from indirect tax changes (like the German VAT cut reversal) and base effects (mostly related to rising energy prices). Although the increase in domestic economic demand in European economies is nothing to be sniffed at, it is also expected to fade in 2022 as output gaps (the difference between actual and potential economic output) and unemployment persist longer term.

Although we’re sceptical a surge in domestic demand & consumption will prompt much earlier monetary policy intervention, that doesn’t preclude more pronounced shifts in central bank rhetoric or formal guidance. The Fed’s current guidance shows no tightening until at least the end of 2023. Even with above-consensus economic growth and rising inflation on the horizon, the bank’s decision to view the post-pandemic recovery through a more dovish lens is a key reason why we don’t anticipate rising policy rates in the US until 2024 (but do see rising bond yields).

Among the G3 central banks, the European Central Bank (ECB) is swimming against the tide in providing more – rather than less – accommodation, stepping up its asset purchases in Q1 with plans to continue in Q2. But we expect the ECB to be more tolerant of higher bond yields as the Euro Area economic recovery takes hold – something we expect to happen in earnest from Q3.

For the Bank of England (BOE), which was mulling negative interest rates just a few months ago, a shift to more tightening before the end of 2021 may seem unlikely. Yet the bank’s own projections suggest inflation will exceed expectations by the end of the year (and may do so more quickly given the pent-up nature of demand). We expect the BOE’s guidance to strike a more decisive tone in the latter part of 2021. While we are sceptical of any actual rate hikes before 2023, we think it may start to slow the pace of asset purchases (quantitative easing, or QE), which could put downward pressure on bond yields in the medium-term.

Key calls:

  • We forecast a US federal deficit of $4.15 trillion in the 2021 fiscal year (18.3% of GDP) and $2 trillion in 2022 (8.2%), more than double the pre-COVID figure.
  • National and federal European authorities should add between 1-2% of GDP in additional fiscal support this year.
  • Sizeable spending likely beckons higher taxes in the UK and US – but deficits will remain large well into the future.

The scale of fiscal stimulus seen over the past year, world wars excluded, has been unprecedented, and the spending looks set to continue – particularly in the US. There, lawmakers passed $1.9 trillion (8.3% of GDP) in new stimulus measures in March, but even before that the government approved some $3.5 trillion in deficit-boosting pandemic support. Focus has already turned to a multi-year, multi-trillion-dollar support package centred on longer-term issues like infrastructure, clean energy, education, health care, and the tax code. Against that backdrop, we expect the US federal deficit to reach $4.15 trillion in the 2021 fiscal year (18.3% of GDP) and $2 trillion in 2022 (8.2%), a record high and more than double the pre-COVID figure.

Fiscal stimulus remains plentiful (% GDP)

Europe and the UK are spending, too. In the Euro Area, fiscal top-ups at the national level and via the Next Generation EU Fund at the federal level should add between 1-2% of GDP in additional fiscal support this year. In the UK, the March 2021 Budget brought an additional £59 billion or 2.6% of GDP worth of additional fiscal measures, split equally between supporting households and businesses.

Deficits will remain large well into the future despite tax hikes. With deficits on the rise, we think tax hikes are likelier than not – but we do expect spending to outweigh tax increases. The March 2021 UK Budget included some back-loaded fiscal tightening (a modest 0.5% of GDP in tax hikes in 2023 and roughly 1% annually in 2024 and 2025), and tax hikes appear to be on the cards in the US. But we don’t expect these to dampen consumption or demand in a material way.

Key calls:

  • We expect to see declining investment-grade (IG) senior corporate bond issuance year-on-year in the UK, Europe and the US in Q2.
  • Investor appetite for longer-dated bonds should rise along with the broader trend towards higher rates & steeper yield curves.
  • Bond issuers that are more sensitive to broad shifts in sentiment or market movements – also known as high-beta issuers – should outperform, in addition to issuers of green, social & sustainability-linked (GSS) bonds.

More modest bond supply and positive economic sentiment is supportive for new issuance and price stability in secondary markets. After four or five months that saw strong credit conditions lead to a huge rise in pre-funding, we expect IG senior corporate bond issuance to slow over the next quarter. In Europe & the UK, we forecast around €90 billion of issuance in Q2 compared with €140 billion for the same quarter last year, though still higher than the three-year Q2 average seen between 2017 and 2019 (about €75 billion). Combined with redemptions and an extension of asset purchases from the ECB, we see this leading to negative net Euro bond supply for the next couple of months and potentially into early June. Overall, this is supportive for issuers despite broadly rising rates, and should keep corporate bond spreads relatively subdued unless volatility returns – perhaps as a result of earlier-than-anticipated central bank QE tapering. For financial institutions (FI), assuming rate volatility remains subdued, we expect senior bond supply to maintain a sustained pace in Q2.

In the US, we also expect a sizeable year-on-year drop in supply over the coming quarter (46%), but as is the case elsewhere, this gulf seems wider than it actually is given the record levels of pre-funding seen at the height of the pandemic in Q2 2020.

For both financial institutions (FI) and corporates, we expect higher-beta issuers to outperform. For corporates, an improving economic backdrop and a low interest rate environment coupled with lower supply should support issuers across the credit spectrum – including lower-rated issuers and those from pandemic-affected sectors where a recovery is expected. Lower-beta issuers should continue to be well-received by investors but may be required to offer concessions in order to compensate for potentially higher rates in the months ahead. For FIs, we also anticipate broadly improving economic & investor sentiment will support higher-beta issuance – and we expect to see more supply heading into summer (Euro-denominated additional tier 1 (AT1) bond supply is down 77% year-on-year).

Broadly rising rates & steeper yield (and swap) curves should bolster investor appetite for longer-dated bonds. As alluded to earlier and as shown in the chart below, we expect US, UK and German government bond yields to rise in the months ahead – with European rates kept in check by a near-term rise in QE – and with that, a steeper Euro swaps curve, which should ultimately be positive for investor sentiment around longer-dated bond issues in the Euro market.

Rising government bond yields & steeper curves as we move through the year (%)

Sources: NatWest Markets, Bloomberg

As ever with bond issuance, timing is everything. In the Euro market, we think April is most supportive, but we could see caution creeping back in as we head towards the end of the quarter as the impact of (relatively) lower QE comes into focus. For Sterling, higher yields are supportive and we are constructive overall, but we are conscious of potential volatility in late April or early May – particularly if the BOE’s tone around QE starts to shift more decisively in favour of tapering. In the US, we entered the quarter favouring the first half of the year from an issuance perspective, given concerns over the vaccination rollout and rising inflation in the second half of the year; but with the vaccinations progressing well and reflation largely priced in through Q1, we remain more neutral on timing.

GSS bond issuance & outperformance will continue. Sustainability has taken on renewed urgency through the post-pandemic recovery and into this year, with GSS bond volumes for Q1 2021 up 322% year-to-date across G3 currencies (Euro, Sterling, US dollar) and equal to more than half of all GSS supply in 2020. Going forward, we expect GSS bonds to continue outperforming conventional bonds – as borrowers benefit from a broader investor base and lower price sensitivity – and continued innovation in the asset class, including the development of the corporate GSS hybrid bond market.

It pays to go green: new issue premiums (NIP) on GSS vs. conventional bonds in the Euro market

Sources: NatWest Markets

UK

  • Growth: we forecast 3.6% growth in Q2 and 5.2% for the year as the consumer-led recovery gathers pace on the back of easing pandemic-related restrictions.
  • Fiscal policy: The £59 billion (2.6% of GDP) of additional fiscal policy stimulus unveiled in the 2021 Budget takes the overall fiscal policy stimulus up to around 9% of GDP, and we raised our investment expenditure forecasts to reflect a boost (or at least a front-loading) of capex as a result of more generous incentives & allowances (4.5% in 2021).
  • Monetary policy: we expect inflation to overshoot its 2% target this year, and although we don’t expect rate hikes this year, the fiscal outlook – historically large deficits of around 16% of GDP in 2020-21 and 10% of GDP in 2021-22 FY – suggests further QE will ultimately be required to lean against any unwarranted tightening of monetary conditions as bond yields rise (possibly £50 billion more QE in early 2022).

Euro Area

  • Growth: we expect a solid rebound for 2021 (5%) and 2022 (5.8%) and despite a resurgence of coronavirus infections in some countries, vaccine progress and a significant increase in savings provide support for a large bounce back.
  • Fiscal policy: national policies are adding further support to measures introduced last year – with fresh assistance for the unemployed & firms affected by more recent infection waves. This will be complemented by the EU Recovery Fund, which starts deploying in the second half of the year.
  • Monetary policy: the introduction of one-off measures (VAT cut reversal, carbon tax introduction) and the base effect (rising energy prices) will likely drive inflation above the ECB’s 2% target later this year (and above 3% in Germany), but only temporarily. Still, the ECB has shown its willingness to stem the rise of bond yields through forward guidance, verbal intervention, and an acceleration of QE.

US

  • Growth: we now forecast real GDP growth at 7.7% in 2021 and 6.1% in 2022, 2% above the latest Blue-Chip consensus (5.7% and 4.1%)
  • Fiscal policy: the $1.9 trillion fiscal stimulus package recently became law and the focus has already started to turn to a multi-year package centred on longer-term issues. We think this will push the federal deficit to $4.15 trillion in 2021 and $2 trillion in 2022, more than double pre-pandemic figures.
  • Monetary policy: we think inflation will edge up in the near-to-medium term, moving just past the Fed’s medium-term 2% target – to 2.1% in 2021 and 2.4% in 2022, but the Fed has clearly been more dovish than in previous cycles and we don’t anticipate any rate hikes until 2024.

China

  • Growth: we see GDP rising 6.8% in the second quarter and reaching 8.7% for this year. We expect consumption to accelerate as investments stabilise, while exports will likely remain resilient in the short term as China continues to fill the global supply gap.
  • Fiscal policy: the government has set a conservative growth target of “above 6%” for 2021, signalling no urgency to adopt any credit-fuelled stimulus. The fiscal target has been lowered moderately to 3.2% of GDP from 3.6% in 2020, and we expect the stimulus withdrawal to be mild and focus on reducing excessive debt growth.
  • Monetary policy: we expect credit growth to slow gradually this year as deleveraging remains a top policy priority. On the policy rates side, we expect the People’s Bank of China (PBoC) to keep benchmark rates such as the Loan Prime Rate (LPR) and Reserve Requirement Ratio (RRR) unchanged throughout 2021.

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ECONOMIC OUTLOOK
Economic recovery
V-SHAPED RECOVERY
CONSUMPTION-LED RECOVERY
SAVINGS
FISCAL POLICY
PANDEMIC
MONETARY POLICY
INFLATION


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