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Economy in Brief

4 Key Questions for Q4
by Andrew Cates  October 7, 2021

There are a number of factors that hold the key for the global economic outlook in the immediate months ahead. They concern the evolution of the COVID pandemic, the tenure of supply-side bottlenecks, how these bottlenecks might amplify inflationary pressures, and how policymakers – and Central Banks in particular – respond to this. We can't possibly pretend to know exactly how these factors will pan out and what their overall impact might be. We can, however, articulate some of the key considerations and, in particular, discuss what the latest dataflow relays about their prospects in the immediate weeks ahead.

Is the COVID pandemic coming to an end?

Let's start with the COVID pandemic and the latest global data flow, which has been positive. Globally new COVID case numbers and fatalities have been in retreat now for four consecutive weeks, a trend that has been broadly based across nearly every major region (see figure 1 below).

Figure 1: New COVID case numbers and new fatalities continue to fall

Vaccination rates in the meantime continue to climb. The World Health Organisation, for example, reports that 6.19 billion cumulative doses of COVID vaccines have now been administered globally as of 3rd October. Analysis from Oxford University's Our World in Data suggests that 3.61 billion individuals have received at least 1 dose (45.8% of the global population), and 2.58 billion (34.2%) are fully vaccinated. That said, there is still a fairly big gap between numbers of fully vaccinated individuals in developed countries versus developing – and particularly African – countries.

Whether or not these data imply that the COVID pandemic is coming to an end is more difficult to answer. That's partly because of the disparities in regional vaccination rates but additionally because of potential complications from new variants of the virus. Still, at the macroeconomic level, activity appears to be returning to more like normal. Even more significantly perhaps, some of the sectoral imbalances that were built up from policies toward lockdowns are moving into reverse. At the big picture global macroeconomic level, for example, restaurant dining activity has been closing in on pre-pandemic levels over the past few months (see figure 2 below). Activity in other consumer service sectors in the meantime has also stepped up a gear. This though stands in contrast with sectors such as industrials, consumer goods and technology equipment, which have seen more of a downshift in economic activity.

Figure 2: Numbers of global diners at restaurants are returning to normal

For how much longer will supply-side congestion endure?

Those last few points on sectoral imbalances and how these may now be unwinding is a neat segue into the next key factor on our watch list, namely supply-side congestion and how long it might endure. Much of that congestion has engulfed manufacturing supply chains and is in part a consequence of relatively strong demand for commodities and consumer goods (compared with services) during the pandemic – and lockdown - months. If, however, consumer demand is now shifting toward services – as lockdowns ease - and away from commodities and other goods, that ought – in theory – to alleviate this congestion.

The latest snapshot of survey data from around the world, however, is not very encouraging on this point. Supplier delivery times and order backlogs are still very high according to the latest September surveys of Purchasing Managers for example. There are widespread shortages of labour too that are restraining activity in many service sectors (as well as in manufacturing). And this is feeding through to higher inflation (see figure 3 below).

Figure 3: Supply side congestion in manufacturing is still acute

There are a few mitigating factors here however that suggest we may now have seen the worst of the world's supply side problems. Firstly – and most obviously – many of those problems are a function of the COVID pandemic. And as already noted above while it seems doubtful that the pandemic will come to an end anytime soon, some of the dislocations that it has rendered are now unwinding. These include imbalances between goods and services markets, the exaggerated strength those imbalances generated for global growth (see figure 4 below), as well as big supply-side bottlenecks - and price increases - in some sectors.

Figure 4: The positive burst of strength in the world economy owes much to solid activity in global goods production

A second mitigating factor concerns the seeming sensitivity of many consumers to those prices that have been lifted in certain sectors. In the language of the economics textbook, the price elasticity of demand in those sectors appears to be quite high (see figures 5). According to the latest surveys from the University of Michigan, US consumer confidence has fallen sharply in recent months. If we drill into the details, moreover, much of this can be traced to high prices and a bigger reluctance from consumers to purchase houses, cars or consumer durables until such time as their prices decline.

Figure 5: US consumers are being dissuaded from major purchases by higher prices

And just as the elasticity of demand seems to be quite high so too perhaps is the elasticity of supply. US companies appear to be rapidly scaling up their capex plans according to the latest durable goods orders data (see figure 6 below). If this capex brings on efficiency gains, enriches productivity growth and contains unit cost pressures – as in theory it should - the existing wave of supply-side congestion ought not to endure for too much longer.

Figure 6: US companies are stepping up their capex in response to supply side shortages

Will inflation continue to surprise forecasters (and Central Banks) on the upside?

This though is another neat segue into the next factor on our list, namely inflation and for how much longer it might create tensions, not least for Central Banks. This scribe has waded into this debate fairly frequently in recent weeks (see, for example, Transitory Inflation, for Now!) so the following points here will be brief. As already noted, current price pressures are undeniably problematic for some sectors of the world economy at present. And those sector-specific pressures could persist in the immediate period ahead. Whether those pressures morph into a more generic – and more permanent – inflation problem, however, is far more questionable. The absence of follow-through to unit wage cost inflation (see figure 7 below), well-anchored inflation expectations and global monetary policy settings that are not necessarily as loose as they appear certainly challenge the idea that the currently high inflation outcomes will endure and ought to leave Central Banks somewhat guarded about a swift policy tightening.

Figure 7: Unit labour costs inflation in the world's major economies is still benign

Will Central Banks now start normalising monetary policy more swiftly?

Whether Central Banks will indeed remain guarded toward prospective monetary policy tightening is more open to question? Among developed economy Central Banks, and over recent weeks we have seen Norway and New Zealand hike interest rates while New Zealand has ended its QE policy and may raise rates before the end of the year. Canada too has halved its asset purchases while Australia is now tapering those purchases. Sweden and the UK too have already indicated that they will end asset purchases this year. And most significantly the Fed has signalled that a tapering campaign will probably begin this November.

How Central Banks more generally now respond to the incoming news-flow will (or ought to) hinge on the factors that are driving inflation. If these are principally supply-side factors as opposed to demand-led factors, Central Banks are likely to stand easy. As Andrew Bailey, governor of the Bank of England put it in a recent speech, tightening monetary policy into a negative supply shock, will not increase the supply of semiconductors, or natural gas. And it could make matters worse by putting more downward pressure on a weakening economy. What will really matter is whether and how expectations of future inflation respond to these supply shocks, and thereby embed rising inflation. And on that that score – and certainly at present – there is good reason to remain reasonably relaxed based on incoming survey and market based data for inflation expectations (see figure 8).

Figure 8: Medium-term gauges of inflation expectations are still quite low relative to multi-year averages

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

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