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Economy in Brief

Beware of the Delta
by Andrew Cates  July 23, 2021

Financial markets have been a little more unsettled in recent weeks. US Treasury yields, for example, have fallen back sharply from their highs in early May and the prices of some commodities - and most notably copper - have generally echoed that retreat as well (see figure 1). Stock markets too have not been as ebullient in recent days notwithstanding some reasonably upbeat US corporate earnings news as well as the underlying support that lower Treasury yields ought to confer.

As ever there are a number of narratives that have been doing the rounds that seek to offer an explanation for what's been going on. Some of these have focused on inflation angst; some have focused on growth concerns; and some have homed in on COVID and the rising global case numbers that have been triggered by the so-called Delta variant.

Figure 1: US Treasury yields and copper prices

There are undeniably elements of truth in all these narratives not least of course because they are inter-linked. But for this scribe global growth worries offer the best explanation. The downward trajectory of bond yields – and inflation break evens in particular – in conjunction with soggier copper prices and heightened equity market volatility certainly chimes more with growth concerns relative to, say, inflation angst.

Indeed just as the so-called Delta variant has clearly been amplifying concerns about the COVID pandemic there is another 'delta' that's arguably been key to the angst about growth. As every student of mathematics knows the Greek letter delta (Δ) signifies 'change.' It is actively deployed in macroeconomic discussions too via differential calculus to signify the growth in, say, GDP, retail sales or consumer prices. And, at present, that 'delta' when applied to the pace of growth in the world economy is weakening. Putting that another way, the second derivative of global growth is turning negative.

The evidence in support of that contention can be seen in forward-looking business surveys (see figure 2 below). Incoming economic data have also elicited a weaker tendency to surprise forecasters on the upside in recent weeks and in some cases (e.g. China) have been surprising more frequently on the downside. As figures 3, 4 and 5 attest below that's been of some significance for financial markets.

Figure 2: Global sentix survey

Figure 3: Global economic surprise index versus Global MSCI PE ratio

Figure 4: Global economic surprise index versus 10 year inflation breakeven rate

Figure 5: Global economic surprise index versus commodity prices

As outlined in our last post on the global outlook (see As Good As It Gets?) there are also a number of fundamental factors that suggest that global growth momentum is set to weaken from here. These include fading fiscal and monetary policy (e.g. credit) impulses alongside higher inflation and weaker household purchasing power.

That last factor moreover arguably now holds the key to how global financial markets evolve from here. The world economy has, after all, been heavily contingent on ample - and unorthodox - fiscal and monetary policy initiatives in recent months. That's fostered looser financial market conditions, boosted aggregate demand and allowed world trade growth to pick up steam. The success of vaccination programmes in some countries in the meantime is encouraging many policymakers that unorthodox policies - not just in the macroeconomic realm but toward lockdowns and social distancing measures too – may no longer be appropriate.

For countries with high levels of debt – including many emerging markets – that's a concern. Higher interest rates that stem either from tighter monetary policy or from higher inflation (or both) could generate financial instability not least for those countries that are heavily dependent on overseas finance. Higher inflation, however, as already discussed, is also eroding purchasing power and threatening economic growth not least now that policy impulses are fading. One way out of this quandary is via higher wage inflation as that would support household purchasing power. But at the same time as this it would obviously exaggerate inflation tensions as well and possibly convince Central Bankers that more monetary tightening may be necessary.

In short, financial markets may be facing a Catch-22 type scenario. Higher wage inflation could allay concerns about growth but exaggerate concerns about inflation and interest rates. Weaker (or even stable) wage inflation, however, could exaggerate concerns about growth even as they ease concerns about inflation. Either way wage inflation is the economic variable that now holds the key to the evolution of markets from here. But the way ahead for markets may equally be a little rockier in the weeks ahead no matter which way wage inflation now heads.

Figure 6: US employment cost index: growth in wages and salaries

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

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