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Economy in Brief

The Return to Normal
by Andrew Cates  July 29, 2021

Is the world now returning to normal? This is a difficult question to answer and clearly hinges on the country concerned as well as what on earth normal might now be. However, many of us probably have now started on the road to normal. Our confidence about how long that journey might take is probably quite low not least because our speed of travel could still be inhibited by COVID-related congestion. But we should be confident that the wheels are in motion, that we’re on the right track and that we’re unlikely now to reverse course.

That confidence clearly comes from the steady rollout of vaccination programmes and increasing evidence to suggest those programmes are working. One of the data points that leads us to that last conclusion concerns excess mortality and specifically how the number of deaths during the COVID-19 pandemic compares to the deaths we would have expected had the pandemic not occurred. As figure 1 below suggests, average rates of excess mortality have now returned to normal in a number of European countries as well as in the US in recent weeks. That contrasts with the past eighteen months when average rates of excess mortality were mostly well above normal and shot up to nearly 40% in April 2020 and to more than 35% last November.

Figure 1: Average rates of excess mortality in the US and selected European countries

Source: Oxford University, Our World in Data. Unweighted average of data for the US and several European countries including Germany, Austria, Belgium, Denmark, Norway, Sweden, Switzerland and the UK. The P-score calculates excess mortality as the percentage difference between the number of deaths in 2020-2021 and the average number of deaths in the same period over the years 2015-2019.

This journey back to normal is already yielding a reversal of some of the trends that had been in vogue during the pandemic. And a further reversal seems likely in the period ahead. Establishing what these trends have been, how big a reversal we are likely to see and over what time frame will arguably be key for the evolution of the world economy and financial markets in the period ahead. In what follows we drill into some of the key considerations.

Goods and services

A first key trend concerns spending activity in global goods markets versus spending on domestic services. Lockdown restrictions and social distancing measures (as well as looser policy settings) had been incentivising consumers (and many companies) into spending more of their incomes on big ticket items that are easy to purchase on the internet or in retail stores that were not shut down (e.g. food and drink). Now that many of the hitherto restricted sectors are being unlocked spending is rotating toward their services (e.g. leisure, hospitality, tourism) and away from goods.

It is difficult to put precise figures on this at the global level but figure 2 below puts the issue into some context. It shows the cumulative deviation of sector-specific purchasing managers’ indices away from the 50 mark, the level that earmarks expansion from contraction. The figure suggests unsurprisingly that the global healthcare sector has been a major beneficiary of the environment we’ve been living in over the past eighteen months. The financial sector, consumer goods, technology and basic materials (i.e. commodity markets) have also performed relatively well. Unsurprisingly, consumer services have fared relatively poorly. It seems fair to conclude that a shift in fortunes will now ensue whereby consumers rotate their spending away from high performing sectors such as consumer goods and technology and towards low performing sectors such as consumer services. Economies that have been benefiting from these trends in recent months – and small open Asian economies that are plugged into consumer goods and technology come to mind – could exhibit a weaker performance in the months ahead as a result.

Figure 2: Global sector PMIs, cumulative deviations from 50

Source: Markit, JP Morgan, Haver Analytics

Insofar as this relative pressure on the consumer goods sector, technology and basic materials unleashed demand and supply imbalances which, in turn, have been a source of higher inflation in recent months, a further implication of that rotation could be inflation relief. There could be broader cyclical growth ramifications too insofar as spending will shift away from goods sectors that typically exhibit high productivity toward services that typically exhibit weaker productivity.

Policy and markets

The cyclical trajectory of the world economy though will also hinge on other considerations including economic policy. As we have illustrated in recent posts (see As Good As It Gets? and Beware of the Delta) credit impulses in the major advanced economies as well as in China have turned negative in recent months. At the same time as this, IMF analysis suggests fiscal policy impulses – including labour market support initiatives such as furlough schemes - are set to fade in the months ahead. Indeed on that last point it is noteworthy that many economists are projecting a sharp slowdown in households’ real income growth in the months ahead (see figure 3 below). That’s a consequence of a number of factors including a fading thrust from fiscal policy as well as the drain on real incomes that’s been invoked by higher inflation.

Figure 3: Real personal disposable income growth in the US, Japan and Europe set to slow

Source: Oxford Economics, Haver Analytics

If the world is now returning to some semblance of normality, however slowly, there will be much less pressure on policymakers to retain unorthodox policy initiatives. As we’ve also illustrated before in previous posts, this matters for financial markets. The trajectory of equity, bond and commodity markets can be traced to ample policy stimulus initiatives and flattering economic data in the past few months. The withdrawal of that stimulus and a weaker-than-expected batch of data threatens to reverse that trajectory and might unleash some financial instability in the period ahead. Inflation considerations arguably hold the key to this.

Figure 4: US 10 year Treasury yields tracking global data surprises

The old normal and the new normal

The outlook from here is not necessarily bleak however. While the return to normal is riddled with uncertainties and periodic bouts of instability are probable there are potentially some longer-term positives that are lurking on the side-lines too. Trend productivity growth in a number of major economies in particular could pick up pace.

Supporting evidence in support of that view stems from a number of considerations. Firstly US business productivity growth has already picked up strongly of late, increasing by 4.5% at an annual rate in Q1 (See figure 5 below). Some of that undeniably reflects sectoral spending shifts toward goods and away from services as noted above. But some too could reflect heightened investment growth in technology. On that last point recent surveys are rich with evidence suggesting that companies’ capital spending growth will remain firm in the period ahead and equally tilted toward potentially productivity enhancing technologies.

Figure 5: US productivity growth versus 6 month ahead capital spending plans (Philly Fed survey)

That workplace mobility indicators in a number of major economies have remained well below normal in recent weeks (see figure 6 below) even as other mobility indicators have perked up offers some hints here of what might emerge. If the working environment and culture has permanently changed, that offers significant challenges – and opportunities – that compel companies to invest and innovate. The pool of labour that’s outside of city centres – including those that have other (e.g. childcare) responsibilities - can be tapped. Potential efficiencies from deploying Artificial intelligence and machine learning that may have hitherto appeared remote could now be worth investigating. Elsewhere recent innovations in the healthcare sector that have been hastened by the pandemic (e.g. breakthrough vaccine technology and a new-found understanding of 3D protein structures) offers significant scope for productivity improvements in that sector and in time could further unleash work opportunities for ageing populations.

Figure 6: Workplace mobility indicators – still below normal

In short the return to normal for the world economy has begun. The road ahead is rocky and congested and great care will be needed to avoid an accident. The end destination however may well be worth the effort and potentially offers more upside for those that are willing to weather the still-sizeable near-term challenges.

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

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