IMF Spring 2021 Meetings: The Glass is All Full

We recently attended (virtually) the 2021 Spring IMF Meetings, where we met with officials from finance ministries, central banks, IFIs such as the IMF, as well as independent economists and experts on topics such as politics and public health. Growth forecasts are being upgraded, interest rates are rising gently, financial conditions are accommodative and monetary and fiscal policy remain supportive. But somehow, the glass is all empty and this setup is very bad for EM. That was the gist of the meetings. Participants were bearish on all things EM—equities and debt. Participants were bullish on all things U.S., especially equities. And what is the big concern driving their worries? Rising yields. That’s it … the big risk is something that is already well in-train, and may even be pausing. This strikes us as a very bullish setup for EM debt. Below are the details.

Global growth galore—forecasts were upgraded, more are likely and it could be durable.

• The IMF (Fund) upgraded its 2021 global growth forecast to 6%, up from 5.2%. The Fund also revised its 2020 GDP upward to -3.3% (1.1% higher than its previous forecast only six months ago!). The Fund is calling this “asynchronous”, but to us it looks staggered. China recovered in 2020, the U.S. is recovering in 2021 and Europe and the rest of the world (ROW) should recover in subsequent years as vaccine roll outs proceed. U.S. growth looks set to be durable, giving plenty of time for laggards. China returned to pre- Covid production levels last year, the U.S. will break above pre-Covid GDP this year, with the rest of the world following, though at a slower pace and with “vaccine versus virus” as a big driver.
• We see the global growth baton being passed from China to the U.S. that could last well beyond 2021. We think it is important to view global growth as staggered, because there was much lamentation at our meetings over “asynchronous” growth. Instead of viewing U.S. and global growth upgrades as generally positive, and following up with a country-by-country approach to see who is growing most (in additional to other variables), there was focus (excessive, in our view) on the potential for higher relative U.S. growth. It was somehow bad that U.S. growth was surging more than most other countries’. Our view is that U.S. growth is broadly supportive of fundamentals and, if there are divergences, sort them out on a country-by-country basis, and do not resort to “U.S. good/ROW bad” frameworks. Anyway, we see a world where the growth baton is being handed to the U.S. in 2021 and which will be handed to current Covid recovery laggards in 2022. That’s a good story, not a bad one, in our view.

The U.S. economy has the growth baton, is running ahead of most forecasts, and may persist.

• The U.S. combination of excess savings, pent up demand and a vaccine amount to a potential economic boom. The big difference between now and the global financial crisis (GFC) is that consumer and corporate balance sheets are in, what we see as, great shape currently. The virus itself and the policy reaction (i.e., lockdowns or not) remain the main risks to growth. But they are fading with vaccine rollouts, as well as less willingness to employ lockdowns. And, growth was ultimately viewed as the only solution to rising debt, while any inflation was viewed as being ignorable by the Fed for the time being.
• We think market participants underappreciate the magnitude and durability of the coming U.S. economic boom, particularly the singular focus of the Biden administration on growth at any cost. Everyone sang the same song of U.S. growth leadership in 2021, but it was not as fortissimo as deserved. Deficits, or the virus, or higher interest rates, or the Fed, or the absence of an infrastructure bill were all presented as risks to continued growth momentum. We note in another section the Biden administration’s singular focus on growth, which we also think is not fully appreciated by markets. The Fed hiking interest rates early was a commonly-presented risk, but we see no evidence for that. Inflation was the more serious risk mentioned, and that topic is important enough to merit its own section.

Inflation and the Fed are the topic du jour—everyone expects inflation, the Fed’s reaction to it was the main question.

• The true path of inflation will be impossible to establish contemporaneously, so it is going come down to the anecdotes we tell ourselves versus what is already priced in. Measured U.S. inflation is rising and this rise will be especially sharp in the coming months due to base effects. Other than that, we do not know much. It is hard to measure the output gap or productivity even historically, let alone in real time. So, whatever the true story will be on inflation, media anecdotes will be a big part of that story. It will be one of labor market tightness, supply constraints, combined with a surge in demand. The key balancing factors are that a lot of this is already priced into markets and the Fed has repeatedly communicated that it will see through any near-term inflation.
• On the “inflation is transitory” side of the docket are the following: Technology. It is obvious and well-reported, but the Covid crisis could be seen as having accelerated long-term trends and pushed up productivity in the service sector significantly. It will be virtually impossible to measure contemporaneously, but a lot of it must seem self-evident to many readers. Similarly, the inflation story so far is one of surging demand and lagging supply in the context of high savings, stimulus and reopening/vaccines. That hardly sounds like a repeated phenomenon, which is what the Fed will focus on. Also, one could make a case that output gaps in ROW are high and not closing as fast as the U.S.’, so some countries may be exporting disinflation, but that is not clear.
• On the “inflation is finally here” side of the docket are the unprecedented policy support for growth, combined with the “growth at any cost” agenda of the new Biden administration. The fiscal stimulus in the U.S. is estimated to be worth around 30% of GDP over two years, which is unprecedented. High savings rates and the reality, or expectation, of further income support may slow the reentry of workers into the workforce. This may be the case especially for older workers, who had kept a ceiling on labor costs prior to the Covid crisis. Scarring is another factor, though we are skeptical of its meaning in service jobs with limited skill requirements. Commodity prices get thrown into the argument, but for central bankers that is almost always going to be viewed as transitory.
• What does this mean for the Fed? Not much and the market is right to not see hikes anytime soon. We think the Fed has been clear and consistent in saying it will see through any near-term inflation, targeting an average inflation rate. This requires it to stay on hold for a prolonged period of time to close the inflation gap. The market has not been pressuring the Fed to do anything, as rates inside two and even five years have been subdued compared to longer-term rates.
• The real problem will come if the U.S. output gap has closed, delivered and anecdotal inflation rise and we begin to see internal disagreement at the Fed; don’t hold your breath. Rising inflation expectations could be a driver here, too. But, overall, we find it very hard to think that the Fed is going to tighten prematurely. All its communication has been to the opposite effect. The coordination between a U.S. Treasury run by the former boss (Janet Yellen) of the current crew at the U.S. central bank (led by Jay Powell) also cannot be under-stated. We also see no evidence of deficit hawks anywhere—in politics, academics and markets. Perhaps the best question to consider about inflation is—Is the inflation we’re going to see sustainable? That’s a trickier question to answer, but it’s the one the Fed will try to focus on, and pushes it in the “lower for longer” direction, in our view, regardless of inflation outcomes. Growth is the answer for the foreseeable future.