TD Economics answers the questions on investors’ minds
14:35, 25 November 2021
TD Economics – the specialist research arm of Canada’s Toronto-Dominion Bank – answers a range of questions that investors have raised about recent issues in business news.
How have recent global economic conditions evolved?
Economic growth has generally disappointed while inflation has shown more heat. In the third quarter of 2021, US real gross domestic product (GDP) is estimated to have grown by an annualised 2.0%, 1.4 percentage points lower than expected in September. The main culprits for the miss were worsening global supply constraints, fading fiscal stimulus and Covid-19 Delta variant-related headwinds. Fortunately, economic rebounds are evident for the fourth quarter.
Supply constraints are showing more staying power than anticipated, causing economists and central banks to serially revise up near-term inflation forecasts. Significant relief now appears unlikely until the second half of 2022. This will leave headline consumer price index (CPI) running just shy of 4%, on average, in the US and Canada, nearly a percentage point higher than we expected in September.
The higher trajectory of inflation in the first half of next year will eat into real disposable incomes in North America and globally. This would normally lead to significant downgrades in 2022 economic growth performances, but the outlook is buttressed by i) large pools of excess savings that continue to support spending patterns, ii) on-going growth in job opportunities.
Where are we now in the battle against Covid-19?
Globally, Covid-19 cases are rising again after several months of decline. The increase is most notable in Europe, while emerging markets have recorded a sharp improvement since the summer peak.
The potential spread of the virus in the coming months could prompt more governments to implement new restrictions. Any new measures adopted are likely to be more targeted and less economically disruptive than those in past waves, given the growing use of vaccine passport systems, mandates and other tools.
In summary, an outbreak this winter should have far less impact on economic growth. We could see some slowing in growth in high-contact services in regions with elevated Covid-19 levels, but the impact on national trends is likely to be marginal.
How worried should we be about China's property market?
The real estate sector has been an indispensable source of growth for the Chinese economy. It is estimated that 30% of Chinese GDP is tied to the upstream or downstream effects of the real estate sector, which is higher than any advanced economy prior to the Global Financial Crisis.
There are now reports of a new regulatory push to investigate cosy relationships between lenders and industry. As authorities look to rein in real estate speculation, this could be another avenue for tightening credit conditions.
This paints a bleak picture, but there are reasons not to expect a crisis to breakout. First, the current situation is a product of regulators imposing rules to limit borrowing by property developers. On 10 November, authorities tipped their hand at a willingness to step in and prevent worsening liquidity issues, as state media reported some real estate firms planned to issue debt in the inter-bank market. State-owned developers too have increased their share of land purchases from local governments, providing support for a key revenue line.
Secondly, the 20th National Congress of the Chinese Communist Party is set for next year. Political appetite for economic instability will be minimal given that the regulatory push on the real estate sector is part of a broader strategy to limit economic inequality.
What if we're wrong and these headwinds prove more persistent?
We estimate that global growth could fall 0.6 percentage points short of current expectations, equivalent to roughly $570bn (£428bn) in foregone real value added. China would suffer the most, potentially losing out on 1.4 percentage points of growth in 2022. Among advanced economies, Eurozone growth could miss by 0.8 percentage points, while the US and Canada could miss by 0.7 and 0.6 percentage points respectively. These estimates offer guidance rather than precision, as it is difficult to estimate the knock-on impacts to the “confidence” channel.
However, the over-riding message is that the Canadian and US economies would be meaningfully negatively impacted, but recessionary forces failed to materialise within the modelled outcomes given the starting point of these economies.
Will wage growth continue to accelerate?
The gap between the rate of job openings and hires remains near a record high, but nothing tells the story of strong demand for workers and rising wages better than record quit rates. Employees are clearly finding greener pastures elsewhere.
The gap between openings and hires also implies a skills mismatch. The pandemic has rapidly shuffled the deck on which sectors and regions are growing most rapidly, and it will take time for workers to relocate, or shift to different industries.
Another challenge for employers has been that labour supply growth has not kept pace with economic growth, as evidenced by a stalled labour force participation rate.
Labour market frictions will not resolve overnight. US history supports a significant amount of time for people out of the labour force to be enticed to re-join. Current higher wages and inflation may hasten the timeline relative to history, but it is also our belief that demand will remain healthy. This combination supports a persistence in wage growth in the 4% to 5% range over the coming quarters.
How do the US infrastructure bill, and potential social spending bills factor into the outlook?
US fiscal policy had been a major support to the economy through the pandemic, totalling over $5trn, or nearly 25% of nominal GDP over two years. The upcoming fiscal spending initiatives are smaller and spread out over a longer period. These include the Infrastructure Investment and Jobs Act (IIJA) and the Build Back Better (BBB) reconciliation bill – currently under negotiation in Congress. Since these packages are more focused on investments to support the economy over the medium term, the boost to growth is unlikely to be realized quickly.
What are the risks posed by excess household savings to the consumption and inflation outlook?
Americans have built a $2.7trn cushion of excess savings over the course of the pandemic, amounting to roughly 13% of nominal GDP. However, excess savings have now stopped accumulating. The personal savings rate returned to its pre-pandemic pace in September and is likely to edge below that level in the quarters ahead.
It is highly uncertain how much of these savings will be spent versus saved and invested. The bulk of savings are held by higher income households with a greater propensity to save. Our baseline assumption was that 5-10% of these reserves are spent over the next two years. Given strong consumer spending data up to October, there is likely upside risk to that assumption. The possibility that consumers go on a larger post-pandemic spending spree is the largest upside risk to growth, and inflation.
How are global central banks reacting to elevated inflation?
With inflation becoming the chief worry among central bankers, a movement is afoot towards tighter monetary policy. The Federal Reserve has taken a first step by tapering its Quantitative Easing program and has signalled a rate hiking cycle is likely to start next year.
The time for very loose monetary policy is over. Central banks around the world are faced with economic rebounds and levels of inflation that haven't existed for decades. This is putting pressure on them to act, setting up 2022 as the year for tandem moves to tighten the screws on monetary policy.