Executive summary

This time really is different

Every recession is subtly different from the last. However, the events that led to the great recession of 2020 were unique, at least in modern times. A sudden stop in economic activity, imposed by governments around the world, to try to prevent the spread of the deadly COVID-19 virus. 

Just as the cause of the recession was unique, so has been the response from governments and central banks. Through large-scale fiscal transfers and central bank actions, households and businesses have been supported through the crisis and are in a position to emerge with their balance sheets largely intact. 

Indeed, so vast has been the fiscal response in some places, such as the United States, that aggregate household balance sheets are stronger than would have been the case without the crisis. 

The nature of the crisis has had a seismic effect on the way politicians and policymakers see their role in society. The Washington Consensus that emerged in the 1990s, already in the process of being dismantled by President Trump, has largely given way to highly interventionist demand management policies that have the potential to persist far beyond the crisis itself. If that turns out to be the case, then this time really is different.

Alongside vast government support, households and businesses have also shown themselves to be more robust and adaptable to circumstances than perhaps was believed at the outset of the crisis. 

As a result, the range of sectors and businesses directly impacted by government restrictions on activity has steadily declined over time. 

Perhaps most notably, the manufacturing sector, which saw very steep declines in activity in the lockdown of 2020 Q2, has rebounded rapidly and continued to steadily expand through the more recent lockdowns. As a result, industrial production is already nearly back to pre-pandemic levels in many major economies. The ability of manufacturing companies to continue to operate effectively has ensured that the supply of goods has continued to grow, albeit at a slower pace than demand, in particular with retail goods spending well ahead of pre-pandemic levels in countries such as the United States where income support has been greatest.

We have not changed our overall view on the potent combination of economic drivers for 2021, which lead us to an above-consensus outlook. Those factors remain: 1) economies reopening; 2) vaccine roll-out largely removing COVID uncertainty; 3) pent-up demand for those activities forgone in 2020; 4) increased savings buffer to draw down; and 5) supportive monetary and fiscal policy. However, we have adjusted our growth projections (Figure 1) to reflect some important developments in recent months. 

Figure 1. Major economy GDP growth projections

First, growth in 2020 Q4 was materially stronger than we expected across all major economies, with the impact of restrictions felt less harshly than anticipated. 

Second, a further tightening of restrictions in 2021 Q1, particularly in Europe, has led us to revise down our growth expectations for the quarter. 

The net of those two factors has left the level of global activity at the end of Q1 roughly in line with our prior expectations, with the weakness in Europe offset by strength in the US and China. However, as we look further into 2021 and 2022, we expect a somewhat faster pace of recovery than previously, with global activity reaching the pre-COVID trend by the end of 2021 (Figure 2). 

Figure 2.  Global growth scenarios
Global GDP scenarios

At the global level, we expect growth to be around 7 per cent in 2021 and 4.5 per cent in 2022. We judge the growth risks to be tilted to the upside given the relatively conservative assumptions we have made about fiscal multipliers and release of excess household savings.

While spare capacity remains in most economies, underlying inflationary pressures are expected to be muted. That said, a variety of factors, such as energy prices, will impact on the year-onyear comparison for both headline and core measures of inflation over the course of 2021, pushing measured inflation temporarily above target in most major economies. 

Just how temporary that proves to be will depend on the pace of recovery. We expect spare capacity to be eliminated much more quickly than in the recovery from the global financial crisis of 2008. Indeed, in the US we expect the output gap to turn positive by the end of 2021, with the euro zone to follow around a year later. That could put upward pressure on underlying inflation in 2022 and beyond, something that we think would be welcomed by central banks, so long as it was not excessive.

Even as the global economy continues to recover through 2021 and beyond, we expect monetary and fiscal policy to remain supportive. Central banks are expected to delay any tightening in policy until inflation has moved above two per cent for a period (Figure 3). And looking beyond the pandemic, many governments are planning to increase spending on public infrastructure, as well as in other areas, to stimulate future growth. 

Figure 3.  Monetary policy to stay very loose

While we think the balance of risks are to the upside, there are undoubtedly downside risks as well, including the potential for COVID mutations that make existing vaccines less effective spreading more widely, as well as the potential for greater economic scarring than currently observed due to the vast range of support measures in place. 

Given our growth expectations for 2021 and 2022, as well as the balance of risks, we prefer to be overweight global equities (Figure 4). 

Figure 4.  Asset allocation summary

Looking across the major regions, we prefer to be slightly underweight emerging markets given they offer too little valuation cushion given the increased risks there of rising US bond yields, weaker local currencies and tighter domestic monetary policy. 

We also prefer to be somewhat more overweight the US and UK markets, where domestic growth differentials, strong policy support and strengthening global trade should be supportive. 

Three months ago, we had expected “high growth” stocks to underperform and “value” and “cyclical” stocks to continue their recent outperformance, as we expected bond yields to continue rising. That has largely transpired, and we expect that trend to continue. 

Government bond yields have risen in recent months, reflecting the brighter economic outlook and increased fiscal support, particularly in the US. We think that longer-term bond yields can rise further, albeit with central banks set to keep policy rates at the effective lower bound for some time, there remains a limit as to how far yields can rise. 

As such, we prefer to be modestly underweight duration. The upside from tighter credit spreads appears to be limited given the narrowing already seen, and therefore we also prefer to be slightly underweight. 

Finally, we are neutral on currencies, with the previous view of a broad-based weakening in the US dollar now more nuanced given the more rapid growth trajectory expected there now compared to other regions.