Paul 0:06
Hello and welcome to Macro Bytes, the economics and politics podcast from abrdn. My name is Paul Diggle, Deputy Chief Economist at ASI, and today I'm joined on the podcast by my co-hosts, Stephanie Kelly, Deputy Head of the ASI Research Institute, and Luke Bartholomew, our Senior Economist. This week we're going to give a taster of some of the key themes running through our latest Global Economic Outlook. At ASI we publish a Global Economic Outlook, or GEO as we call it, each quarter. Many of the themes we analyse in that flagship document we discuss on this podcast. But today we're going to do a whistle-stop tour of a number of those themes: vaccines; COVID variants; inflation; monetary policy; geopolitics; and climate policy. So as always, there is a lot to talk about. I'm sure Luke and Steph will be very insightful on these topics. So let's get right into it. So the overarching theme of our latest Global Economic Outlook, we are calling "peak growth". And the idea is that the global recovery is clearly decelerating. Initially, the recovery was exceedingly sharp, very rapid. We did a whole podcast on how the recovery was different and one of the features of it was quite how rapid it was in some of its earlier stages. But we knew this was never sustainable, there's no surprise that the global recovery is slowing. But what we've observed in our work, in our forecasts, over the past few months is that a number of headwinds to the global recovery, which weren't really there before, have emerged. And that means that the slowdown is proving a little bit more rapid than we’d previously expected. And indeed, some of our global views have had to moderate a bit. And those headwinds are: the Delta variant and the fourth global wave; a slightly tighter path for monetary policy at a lot of the major central banks; and related to some of those [is] a particularly rapid slowdown developing in China, alongside something of a regulatory crackdown. So our forecasts still have several years of above-trend growth ahead of us, we still think the world economy is firmly in the recovery phase. But the peak has certainly passed, it's going to be tougher going from here. And that has, I think, interesting asset price implications as the going gets a little bit tougher. But let's talk through some of these key themes, why the recovery has slowed a little bit. Steph, clearly one of the overarching themes has been the pandemic of course, but in particular, the emergence of the Delta strain has changed the game in a number of respects. So tell us about why Delta makes the recovery harder going in countries that are really trying to eliminate the virus, and how those that have done very well with vaccine rollout are dealing with the Delta variant.
Stephanie Kelly 3:05
Sure. So I think it all comes down to infectiousness. It is a very infectious variant, it travels easily from person to person. So the risk if you get COVID, you pass it on – it's higher. And what that means is that for countries that had previously been relatively successful in what we'd call a “max suppression”, so you think of Australia and New Zealand where maybe they'd been a little slower on the uptake when it came to vaccines, in a way because they didn't have the same necessity as you saw in places like Europe, the UK, the US. What they've seen now is these big breakouts, and it's just really hard to stem them because of just how infectious this variant is. So it's a real challenge for them, I think [it] is serving as impetus to really accelerate vaccine programmes. For example, our Australia vaccine forecasts are set to ramp up massively in the next six months. For countries like the UK, European countries, the US, we're moving into [a] really strange new phase where essentially Delta has changed it, so that now when we talk about efficacy of vaccines, we're no longer talking necessarily about, do you have COVID? It's, are you symptomatic? And, will you get hospitalised and die? And that shift is really profound because it changes the calculation when you think about economic reopening and the risks we all face as we go out into the economy.
Paul 4:25
And we found it helpful to sort of split a lot of countries up, according to where they are in terms of [whether] their vaccine rollout is more or less advanced, but also crucially, their COVID handling strategy, because as you say, Steph, it's so important now, whether you're trying to do “max suppression”, especially if you don't have much in the way of vaccine coverage – Australia being the obvious example, heading back into lockdown. Or if you're adopting a more permissive approach targeting hospitalisations and deaths, which really get pushed lower by the vaccine, and you're able to reopen to some of those countries that are sort of in the zero COVID, the “max suppression” strategy – China's one, Australia is another, perhaps Japan is to some extent. Are there any signs of a shift away from that strategy in those countries? Can we expect them to go more towards the US or the European model?
Stephanie Kelly 5:13
Yeah, I think you're starting to see it already, to a degree. And again, you kind of have to separate some countries from others based on their ability to do mass testing and to interact with the people. And what I mean by that is, the Chinese model is just quite a different kind of a model to Australia and New Zealand for lots of different reasons we've talked about before, but I think there are reasons to believe that that shift is likely to come in quite a few economies, more out of necessity than anything else. And again, as you noted, it interacts with the vaccine. So the more vaccinated the population is, the more countries will become comfortable with it. But I think it is just a very difficult environment to believe that “max suppression” is going to be the path forward, particularly for those in Australia/New Zealand, who can see their developed market counterparts opening up and kind of living with the virus. That's a difficult juxtaposition for the populace of those places.
Paul 6:07
Great. And we've described this as driving a divergent recovery. That's another one of our characterisations, as well as peak growth. Divergent recovery according to where you sit on this COVID handling, vaccine rollout schematic. So a few other important vaccine developments then. What are the latest? What's the latest evidence on waning immunity? How does that interact with third-dose boosters? And should we expect the rollout to younger populations in a lot of economies as well? And how much does that help?
Stephanie Kelly 6:37
So I think they actually are all relevant to each other. Take the younger population, because of the higher infectiousness of the Delta variant and the fact that what we're seeing is that the [vaccines are] less effective, particularly against asymptomatic disease, which you might say is not problematic for the individual who's asymptomatic, but creates a lot of spread such that quote, unquote, “herd immunity” seemed much further out of reach. And if anything, you'll notice in the UK and the US and Europe, there's much more of a shift where policymakers are talking about kind of getting vaccine immunity, and then additional natural immunity seems to be the path to get stronger immunity for the population. That's quite a significant shift from where we've been. So I think we know the vaccine is less effective in terms of asymptomatic disease, still highly effective against hospitalisation and deaths, which is where policymakers are now tilted in those countries of high vaccination. We know that there's mounting pressure to vaccinate children, the challenge you have of course is the children don't tend to get very sick. So the public health debate is around, do vaccinate children because of the damage it could do to their education, because they have to be out or, you know, the pod systems, they're being phased out, but it's still very disruptive to education to have these cases. And from a public health perspective, in terms of boosting overall immunity, reducing the risk to caregivers of those children who might be higher risk. All of that is really in debate and different countries are at very different stages. The US [is] already vaccinating over twelves, Canada I believe as well, a couple of European countries are looking at phasing it in. But then other countries, particularly here in the UK, it's still very much up for debate. Well, I think it's going to be something that, [in] my view, is ultimately likely that they phase it in over time, but they're not there yet. And I think that's the next leg of the vaccination route to go.
Paul 8:24
Great. So let's perhaps move on to more familiar pastures for us economists – inflation and the monetary policy outlook. So we've done a number of episodes now on the inflation debate. It's been a crucial debate in financial markets. And we've sort of laid out our store, which is we are in “team transitory”. We think that there are significant but transitory upward pressures on price levels to do with energy base effects and to do with supply bottlenecks, both of which there are good reason[s] to think will fade in time, but that time might be, you know, some way into next year. Luke, one of the key parts of that debate is whether there are second-round effects, from price pressures in wages and expectations. What are we seeing on that front?
Luke Bartholomew 9:09
Thanks. Well, yeah, so I guess the first thing to say on the wages front is that the data is a complete mess right now. It's extremely difficult to get any clear read out of the data, at least at the headline level. And the reason for that is that there are huge compositional effects at work in the labour market. So the kind of people that tended to lose their jobs in COVID, or take pay cuts, tended to be at one point of the pay distribution – they weren't evenly spread. They've been quite low paid and that had distributional compositional effects on the pay data last year. And this year, as people who've returned back to the labour market, where we're seeing growth is tended to be again, typically in sort of hospitality services that was, at least at the start of the summer, where some of the most rapid growth was. And again, if those people are systematically on the lower end of the pay distribution, that again skews the kind of composition. So you have those compositional effects that distort the headline level. And the second thing is that, for example, in the likes of the UK, that is compounded even more with the impact of furlough, how that interacts with paydays, the 80% pay that we were getting on furlough as they come off, that ends up looking like quite large pay increases, especially when compared on an annual rate with this time last year. And indeed, that's one of the reasons I think the government is in a bit of a headache around this question of how much to increase pensions and whether that should be tied to the question of wages, because we are seeing such extraordinarily (sic), at least on the face of the data, pay increases. But those really are just compositional things, rather than telling us anything more fundamental about the structure of the labour market. All that being said, I do think there are a few observations that we can make. First is that there does seem to be genuine, and not just anecdotal but genuine, you can see it in the data, pockets of wage pressure. We used to talk a lot about particular sectors where there were shortages and I think we are now starting to see in those areas that there is stronger wage growth there. Lorry drivers are an example in the UK. But there are other sectors across the world where there are various sort of dislocations between supply and demand and ultimately, it's higher wages in those sectors that are required to get the reallocation of workers to where they need to be but that shows up potentially, in slightly higher wage growth, albeit if it is contained to just a few sectors. And if those are relatively low-paid sectors, it might not have a huge impact. So I don't think there's anything inflationary per se going on there, although in those sectors, it will look like quite strong pay growth. And then on the expectation side, and I think that ultimately is, if you were to worry about a more entrenched period of inflation it has to be because expectations get unanchored. And on that we are definitely seeing a creeping up of expectation, some of the consumer sentiment surveys, some of the surveys of manufacturers and other businesses, when they're sort of asked to think about pressures in their supply chains, do talk about there being these upward price pressures, so it's there, I think to an extent, in expectations. But to put this in context, we've had years of well below target-consistent expectations and really what we're seeing more than anything else is a ratcheting up of expectations broadly, where they should have been for the last 10 years, rather than anything more worrying that should make us think there's some sort of unanchoring going on.
Paul 12:53
Great. And you've explained to us in previous episodes, why the longer-term inflation regime probably won't be a shift to much higher inflation because there's still a decent output gap in the economy. Expectations, although moving higher as you said there, are reasonably well anchored and fundamentally central banks still target inflation and have the tools to keep it under control. And on that point, we've actually seen some interesting monetary policy shifts, which we dig into a lot in our Global Economic Outlook, the most important of which is that the Fed now has a clear timeline for tapering and perhaps a less clear timeline, but there is one there, for rate hikes. What did we learn, Luke, from Jackson Hole? And what [is] the Fed's big set piece where it laid out some of these and what are we expecting for the Fed hiking cycle?
Luke Bartholomew 13:41
I think I'd say clear-ish timetable for tapering rather than clear, per se, in the sense that it does look extremely likely that it is going to be this year. I do think it is 2021’s business now, but there is still some uncertainty as to whether that starts in November, December. Exactly when the timing of that is going to be, particularly in the context of the [audio unclear] report we received just recently, which was a little bit disappointing, perhaps that stays the Fed’s hands a little bit at the upcoming September meeting. So it is a bit of a “we're not sure quite whether it's November, December” but our base case is probably that it actually starts the tapering process in December this year. What was clear from Jackson Hole, is how adamant the Fed is on its message that tapering is not the beginning of the process, or it shouldn't be extrapolated to be the beginning of the process, of a significant rate-hiking cycle. Chair Powell went out of his way to try and separate those two things, that the bar for hiking is significantly higher than it is for tapering, the amount of progress that they need to see towards full employment and how high and sustainable inflation needs to be to get to that point. So I think that gives a very important message for markets, that tapering isn't the beginning of a rate-hiking cycle, at least anytime soon.
Paul 15:11
And the reason he wants to drill that message home, of course, is that, that dynamic that people extrapolated from tapering towards a rate-hiking cycle was what drove the “taper tantrum” in 2013 – the big sell off in equity markets, the big sell off in bond markets around that announcement. So what should we expect this time around? Are we going to have that kind of tantrum dynamic? Or is the Fed able to, sort of, sidestep that with skilful communication?
Luke Bartholomew 15:41
My best guess is that tapering ends up being a bit of a snooze fest, to be honest. It's the kind of thing that we talk about a huge amount, but in terms of what it does to financial conditions, when it actually starts, what it does to financial markets and the economy, I think it’s going to be pretty minimum. And there are several reasons for that. One, I mean, we've been talking about it so much. They're not just talking, but “talking about, talking about” tapering, which has given financial markets plenty of time to adjust and build in their expectations around them. Secondly, precisely that point that we were both talking about, that a large reason we think 2013, the original taper tantrum, occurred is because the tapering announcement was taken as a signal – a path to higher rates being embarked on. And it was those expectations about higher future rates, that was really doing a lot of the work of tightening financial conditions. To the extent to which the Fed has been able to separate those two things, I think it has been pretty credible to that message, then that should also mitigate the impact of tapering on asset markets. And the third, sort of less in terms of what the Fed itself is doing but more the rest of the world, because I suppose a big part of the tapering story was not just that the Fed was tightening monetary policy back 2013, but there was also this sense that there's a lot of vulnerabilities in emerging markets and imbalances, and that's why a lot of those guys came through that period with a fair degree of pain. Well, this time around, I think it's fair to say that those imbalances are much smaller, that emerging markets are in a stronger place and so also well placed to weather any potential impact as well. So I don't expect it to be an especially big deal to be honest.
Paul 17:32
Steph, let's move on to some of the political issues that we talked about in the latest GEO. And there's a lot there. One of them that you've been covering in depth is the passage of US infrastructure. Where are we with these two bills? And what are we incorporating for our US infrastructure forecasts?
Stephanie Kelly 17:50
Yeah, so we're kind of in a strange and drawn out phase of the two bills passing side by side. So to remind people, there's a bipartisan infrastructure bill, which is $550 billion in new spending and investment. And then alongside that, but slightly behind it, is the partisan [one], so the Democrats are trying to pass this bill by themselves without Republican support through a process called reconciliation. And at the moment, they've kind of got on the back of an envelope written down, $3.5 trillion, which is a huge number. So the debate that's going on at the moment now is around exactly what kind of spending you do. And we do have some indications around the kinds of spending that they intend to do. How do you pay for that? Over what time period? It's quite a complex process. And where we're at right now is quite a lot of push-pull between the moderate Democrats, particularly in the Senate, and Joe Manchin is the most visible on this writing op eds about his preferred approach, versus the, sort of, leadership. And I think where it leads to and what we've got pencilled in, is essentially, that this $3.5 trillion is probably too big to pass completely funded. And that's what the moderate Democrats want, they want it to be completely funded, no deficit spending. I think that's unlikely. So what we've pencilled in, actually since the start of the year, has been about $3 trillion, including that $550 billion from the bipartisan deal. So that leaves us at about two and a half trillion. Now, that might drift up a little bit, depending on how things go within the Democratic Party. But at this point, it is very much a “what's happening in the Democratic Party?” that's going to ultimately decide the size of this bill. We feel pretty comfortable with 3 trillion, but we are in a world in which, all of a sudden, what's half a trillion dollars between friends? It's just a very different stage of fiscal policy in the US, but one in which we do expect there to be quite a significant investment when it comes to infrastructure, climate spending, and social care kind of spending.
Paul 19:54
So some big market implications and some big numbers we're talking about. So another area of politics that we're tracking closely, Steph, is upcoming German election. Now the polls have been all over the place there. There are a lot of coalitions that are possible post the German election. Why don't you talk us through a few of those and how policy could be different and the different coalition options?
Stephanie Kelly 20:18
Yes. So this is extremely complicated. I'm going to try and explain it in a way that doesn't require you to necessarily be a German policy expert to get the point of this election. So originally it looked like the CDU/CSU, which is Merkel's party, although she is stepping down, which is very significant, it looked like they were likely to go into coalition with the Green Party. And that was everyone's sort of base case for a long time. Until recently when leadership failures from both the Green Party and the CDU/CSU, so the new leader, Armin Laschet, and the leader of the Greens, Baerbock, both really struggled with things like leadership messaging, and gaffes, and there were just some very idiosyncratic issues that they faced. And what that's led to is the emergence of a huge popularity for Olaf Scholz, who is the leader of the SPD and is quite well known in Germany. So there's this new phrase which is like "Scholz will fix it" or "Scholz will do it", that kind of idea. What that's done is really open up quite a lot of potential coalitions, so the key parties I think to watch are obviously you've got your two big parties, the CDU/CSU, and the SPD. They're the two big parties, centre right and centre left. Then actually the kingmakers of this election are likely to be the Green Party, which does what it says on the tin, it's the Green Party keen on investing in green climate policies as well as digitalisation, which is generally a popular idea in Germany. And the FDP, who are a right wing, very kind of market-centric party. The challenge you have is what coordination will take place between these three parties and honestly, in the German system, particularly with the electoral system they have, it's very unclear. So people talk about “traffic lights” and they talk about “Jamaica”. So a “Jamaica” coalition is one where you have the CDU/CSU as your bigger party and the Greens and the FDP. Then you've got your “traffic light”, which is where you replace your centre-right party with your centre-left party, so now you have the SPD, the Greens and the FDP.
Paul 22:23
And those words are to do with the colours of the flags, that the colours of the parties [audio unclear] ?
Stephanie Kelly 22:27
Yes, because we all are able to memorise the colours of the parties for all of these, exactly, very complicated! So there are a couple of other coalition possibilities. But I think those are the big ones at the moment. I think other coalitions will be harder to negotiate. But for me, it does come down to how do you find the centre ground in policy between the FDP, who are not very supportive of significant tax hikes and significant government intervention, and the Green Party, who are clearly very pro-government intervention, who want to do things like increase taxes in order to fund climate policy. And I think that's where the crux of this election is going to end up. It does matter who the big party is, but I don't think it matters as much as people say, because actually Olaf Scholz, even though he is of the centre-left party, he is relatively conservative himself. So I think it's in the coalition negotiations that the market implications are going to get drawn out.
Paul 23:20
Yeah. And he's obviously the current finance minister of Germany, in the grand coalition. So I think one of those market implications, Steph, is who, as you say, who is that kingmaker because they potentially have quite different fiscal implications. A Green Party kingmaker pushes you more in, towards a fiscally expansionary direction, potentially interesting, unusual, for Germany. FDP back to the imposition of the German and European fiscal rule. So quite divergent implications. So let's close then with what's increasingly an absolutely crucial theme for the macro outlook and markets, which is climate policy. Steph, we're going to do a whole series of podcasts in this stream on COP 26, and how we're thinking about climate policy and macro. But why don't you give us a few of your initial expectations for the COP26 conference.
Stephanie Kelly 24:14
So I think COP 26 is going to create a lot of headlines. But where the nuts and bolts really matter is how individual countries who come to COP, and who make big promises, make that happen at the domestic level. Because the reality is, outside of the European Union, which obviously is a very different kind of a body, any kind of climate policy that happens needs to happen at the country level. And the key countries who need to be involved are the United States and China and both are going to talk a big game. I don't doubt that. But the key question is going to be: how do you follow through on that? Do we see genuine [audio unclear] rates? And in both cases, while the countries are making progress, both sides are, you still see significant challenges. So in China, there's still a lot of coal plants being expanded and being utilised, which is an issue. In the US, while there is support for climate policy action [in] the Democratic Party, it still faces a lot of pushback even within the party so that you kind of get this, kind of at the edges, progress gets pulled back. So I think that's what we're really focused on when it comes to COP. But COP’s not the only one. And again, as you said, Paul, we’ll go through this in our climate series in October, November. But one issue we need to bear in mind is it's not just about government policy anymore. You obviously have done a lot of research into the role of central banks when it comes to climate policy and the role they might play. And the other one we're focused [on] a lot is the judiciary. So courts are playing an increasingly important role and there's an intersection because if countries make big promises at COP 26, their courts can hold them legally accountable if they are challenged constitutionally, and that's something to bear in mind as well. So there's a lot of feedback loops between governments, central banks, courts and companies themselves, who ultimately don't exist in a vacuum. They are subject to laws and rules and regulations. So all of this, I think, is going to be quite a complex interplay, which will be really relevant to investors in the next couple of years.
Paul 26:15
Yeah, super relevant, as you say, because those companies have to follow those rules set [audio unclear] governments. Sometimes they are hauled up in front of the courts, and may increasingly be so post-COP26. Because you see that trend historically, that climate-related litigation increases post- big international agreements. And of course, they're extremely impacted by what central banks do. And Luke, let's close with what central banks are doing on climate policy then, because as Steph says, they're increasingly a climate-policy actor. What are they doing and how does that affect the macro outlook?
Luke Bartholomew 26:47
So the Bank of England has recently been given an explicit mandate from Parliament to take into consideration climate-based issues when it does things like green QE and, more broadly, as it goes about pursuing its business. And the ECB, the European Central Bank, at its recent strategic review, also took on certain climate responsibilities as well, consistent as it sees it, both for its primary mandate for inflation, stabilisation and financial stability, but also, and I think perhaps more tellingly, its secondary mandate of ensuring that European Union objectives, and clearly climate is a key one, are also pursued as well. I think the really interesting question at the moment is around the US. And as we talk, the question of Jay Powell’s reappointment to Fed chairman is a hotly contested political issue. And the reason it seems that it's so hotly contested is that there is a part of the Democratic Party that would like to appoint a new chair, who was much more willing to use the levers that the Fed has, to try and influence climate policy. And that might partly be because it's so difficult, it sometimes seems, to do anything through the standard conventional route in the US, so they're trying to pull every lever that they can by appointing more sympathetic policymakers to the Fed as well. So yeah, I think it's a really important issue to watch right now and I think could play out relatively soon in terms of who ends up running the Fed around this issue.
Paul 28:29
Brilliant. Well Steph, Luke, thank you both very much. It’s about all we have time for. But that was a whistle-stop tour of some of the key themes that run through our latest Global Economic Outlook that we're discussing all the time with investors. And you can read more on the abrdn website where we have our latest Global Economic Outlook posted up there. But thank you for listening to the podcast. Don't forget to like, or subscribe, on your podcast platform. But until next time, goodbye and good luck out there.
Voice-over 29:09
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