A Second-Half Surge, or Pause?

The growth and inflation argument continues

Our macro economists agree that developed world economies seemed to be on the path to economic normalization in the first half of 2021, but the question remains: what’s next? Critical variables in play include potential impacts from inflation, the pace of vaccination rollout globally and central banks’ approach to monetary easing policies.

In this edition of Macro Perspectives, we highlight views from five of our specialist investment teams on inflation, interest rates and growth.

Inflation, especially inflation expectations, continues to be a significant focus for our investment teams. Inflation figures continued to rise in several countries in June and July, driven by a combination of factors that included cyclical upswings associated with either resurgent sustainable economic activity or pent-up demand paid for by the spending of excess savings. Because of this, there is a debate among our economists on whether inflation will remain transitory or continue to remain at high levels into 2022. Alternative measures such as the volume of news stories on shortages in categories such as autos, furniture, electronics and apparel peaked in April/May, indicating that there may be evidence of inflation abating in the future.¹ However, reported data continue to show sharply rising prices, which put pressure on fiscal and monetary authorities to adjust policy to prevent economic overheating.

Our contributors’ views also diverge on what economic growth will look like in the second half of the year. The global economic recovery rolled forward through the second quarter, most notably in developed markets, as business activity reopened, coordinated monetary and fiscal policy provided a healthy tailwind, and growing levels of vaccine coverage moved parts of the world closer to normalization. However, there is uncertainty about the pace of economic recovery for countries that lag behind in vaccinations or experience the proliferation of various COVID-19 variants. The initial expectations for how economies would recover based on the shape of the COVID-19 peaks have been tested even in countries with high vaccination rates. For example, Israel has seen cases and hospitalizations rise even with high levels of vaccinations (93% of adults with nearly all receiving the Pfizer vaccine) and has already ordered boosters for its citizens.² The volatile nature of how governments and consumers will respond from a policy and behavioral perspective creates a wide range of potential outcomes. Below are summaries of our economists’ current views:

Western Asset

• We expect to see a meaningful pickup in global growth in the second half of 2021 as economies continue to reopen; however, we are cautious about extrapolating short-term cyclical boosts into a presumption of a higher secular trend rate of growth or inflation.

Sonal Desai, Ph.D., Chief Investment Officer of Franklin Templeton Fixed Income

• Optimism and consumer confidence have rebounded sharply, with a sustained global recovery now the baseline expectation. Uncertainty remains as the pace of economic recovery is diverging between those countries that have been able to bring infections under control, have accelerated vaccination campaigns, and have supported the economy with ample amounts of liquidity via exceptionally loose fiscal and monetary policy, and those that continue to lag behind. We believe investors should be prepared for increased volatility as the market tries to interpret the changes in policy regime.

Michael Hasenstab, Ph.D., Chief Investment Officer of Templeton Global Macro

• We expect inflation figures to remain elevated in 2021 in many countries, driven by a combination of factors that include cyclical upswings associated with resurgent economic activity, supply bottlenecks in certain sectors and base effects of the pandemic shocks in 2020. These factors should be largely transitory, in our view, with inflation levels eventually moderating to secular trends in 2022, given elevated unemployment and automation factors that continue to dampen wage pressures.

Gene Podkaminer, Head of Research, Franklin Templeton Investment Solutions

• We remain confident that a stimulative mix of easy monetary policy and generous fiscal support should build an increasingly synchronized global expansion—certainly among developed markets. However, this move may be close to its peak. In absolute terms, the strongest period of expansion may have been in the second quarter of this year. The United States may be approaching the point of “peak fiscal stimulus” and is perhaps on the downslope for quarterly growth in gross domestic product (GDP).

Francis Scotland, Director of Global Macro Research at Brandywine Global

• The normalization of the world’s major economic regions—at least in terms of real GDP levels—marks the end of the second phase and peak economic growth. The current trajectory should moderate, and growth should slow; what is ambiguous is by how much. Currently, markets seem priced for the middle road—a soft landing. If there is any tilt to the bias in the outlook, it is probably that the world runs too hot.