With the return to growth since the onset of the COVID-19 pandemic, what opportunities can be expected for a sustained recovery across the global economy and emerging markets?

A scenario where the global economy emerges stronger post COVID-19 is quite plausible based on a combination of factors coming to the fore. The acceleration of digitalisation, alongside enduring policy support, are two key areas that have produced favourable conditions for growth and raised expectations for future corporate profits, particularly in the US, and in other economies to a lesser extent. Much of these forecast gains have been priced in and while we're open to the possibility of these earnings being realised, there are a number of structural headwinds to bear in mind.

The first of these is a long tail of low productivity firms expected to weigh on the overall growth trend. Looking to emerging markets specifically, we see a moderation in demographic forces that have driven a very positive growth story across many developing countries in the last 20 years. Looking towards the next 20 years, the rate of expansion in youth populations and participation rates is slowing, creating another headwind that could dampen growth in emerging markets.

On balance we would expect this expansive post COVID-19 growth era to be relatively brief and be followed by a transition to a stable, more sustained recovery owing to these significant structural headwinds.

As inflationary pressures gather and governments respond, is this macro theme likely to become a cause for concern for fixed income investors?

In responding to the widespread economic disruption of the pandemic, many central banks have loosened monetary policy to a degree. However, these measures have been far from uniform across the globe, with many major central banks in the developed world, particularly the US Federal Reserve (the Fed), altering their strategy to manage economic development in a number of important ways.

Firstly, they’re more likely to respond to inflation outcomes rather than to inflation forecasts. This results in central banks essentially becoming more behind the curve. They’re also placing a far greater emphasis on providing favourable financing conditions as a key stimulus measure for economic activity. The pandemic has also heightened concerns from leaders in developed countries about inequality within their borders, further influencing the economic policy agenda.

With all these factors combined, there is a strong tendency for central banks to keep the scales tilted towards stimulus, placing more weight on unemployment and growth outcomes over inflation concerns. If this policy stance were to continue, with central banks looking at growth factors rather than inflation outcomes to determine their path forward, this would contribute to our view that actual inflation could overshoot forecasts in the near-term.

However, the markets’ apprehension regarding the strength of these inflationary pressures could lead the Fed to take a less patient approach. From announcements made late in Q3, the Fed appears to be aligned with our view that the inflation spike will be short-lived. Recent price increases are mainly being triggered by supply chain disruption and the surge in demand for some goods and services as economies have opened up. As the chart below suggests, this kind of inflation tends to be transient; we believe it is likely to stabilise later next year and subside as we head into 2023 and 2024. Over the medium term, however, the risk remains that a continued and disruptive inflation situation could force the hand of the Fed.

 

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