The causes of the pandemic recession were different to anything from the post-war era, so should we expect the economic recovery to be different too? How should markets price this recovery and what should investors look out for?
Welcome to another week of Macro Matters. In this episode our host Paul Diggle is joined by Jeremy Lawson, Luke Bartholomew and Robert Gilhooly from the Aberdeen Standard Investments Research Institute. A year ago, Luke and Paul’s research report ‘How is this recession different?’ considered how the economic shock from the pandemic differed from any recession seen before. Now, 12 months on and with the bounce out of the recession underway, the question is around the nature of the recovery.
Luke begins by discussing the shape of the recovery and the extent of monetary and fiscal policy support.
Jeremy asks whether this recovery is the start of a new business cycle or a continuation of the previous one, and explores divergences in the goods and services sectors.Bob focuses on how the recovery may vary between emerging and developed markets.
If you’re enjoying Macro Matters, we’d like to hear from you. Share your thoughts on episodes past or give us ideas on future topics by dropping us an email using firstname.lastname@example.org. You can also continue the conversation with us on LinkedIn too.
Please note that email is not a secure form of communication so please don't send any personal or sensitive information.If you missed last week's episode of Macro Matters, catch up now and join our guest host, Luke and James McCann as they discuss the US economy and inflation outlook.
Macro Matters: how is this recovery different?
Hello, and welcome to Macro Matters the economics and politics podcast from Aberdeen Standard Investments. My name is Paul Diggle, and along with my co-host Stephanie Kelly, we're guiding you through the macro economic and political themes that are driving global markets. And today we're asking the question, how is this recovery different? Just as the global recession created by the COVID, shock was highly unusual, the recovery out of the crisis is also going to be atypical in all sorts of ways. It's incredibly rapid, yet it could leave a legacy of long term scarring, it's going to be services rather than manufacturing lead. And it's spearheaded by developed markets rather than emerging markets, all unusual features of a business cycle recovery. So joining me to discuss how this recovery is different. Jeremy Lawson, our Chief Economist, and Luke Bartholomew, and Robert Gilhooly, two of our Senior Economists. Luke, let's start with you. So you were hosting the podcast last week, but you're back in the guests seat. today. A year ago, the two of us co-authored a paper called 'How is this recession different', but Fast Forward 12 months, and we're hopefully in the recovery phase, some of the features of the unusual nature of the recession that we identified 12 months ago, where its length, its short length, its incredible depth, and the speed at which that contraction happened, and also its synchronicity across countries. How is the recovery phase playing out in terms of those variables? Length and depth and synchronicity?
Yeah, I think the first thing to say is that it's no longer asynchronous, right. One of the distinguishing features of this recovery is quite how divergent it is. EM DM divergence and within the developed market complex as well, there are quite significant divergences. And obviously, that reflects progress in terms of keeping the virus under control, progress in terms of vaccine rollout, and then policy as well. So yeah, the first thing to say is that different economies recovering at different speeds. And I think for some of those economies, it is pretty much a mirror image of what went before. So a very sharp downturn, very short downturn, is being followed up with a very, very quick recovery over a quite short period of time. And I have the likes of the US and China, in mind for that, again, reflecting both vaccine policy and economic support, as well. And I suppose, the size of the US and China is such that by the time those two have had a pretty sharp recovery, actually, at the global level, things start to look that way, as well. But that does disguise that there are a number of countries that are experiencing a much slower recovery or indeed, double dip, triple dip, potentially as lockdown measures have come and gone again, policies being more or less supportive. And so for those countries, they could end up tracing out a profile of GDP that looks much more like the recovery from the global financial crisis and over the from 2008 onwards, and that is a sluggish recovery, struggling to get both real output and nominal activity. So inflation as well anything like back to the trend levels that it seemed before the GFC.
And that last sort of slow recovery was certainly very, very characteristic of the financial crisis, thinking back to previous and more typical business cycle recessions, I think what we observe is, you do get some lasting legacy some hit to the long term growth path, but certainly nothing like on the scale of the financial crisis and the fact that lasting hit will actually be quite divergent across economies. I think that's an important feature of the recovery, as you say there, Luke. But what about policy support then? So the recession was met with enormous policy support, and that is, of course, boosted the recovery, at least in a subset of economies, like the US that you identified. Is the scale of policy support during this recovery, atypical or unusual and should that give us sort of different expectations for the recovery we face them we might ordinarily have?
So I think if you just look at the brute numbers of the thing, how much interest rates are cut, how big Central Bank balance sheets got, how large government deficits got the kind of policies that would be experimented with, all of that seems to be extraordinarily large. But I think it would be something of a mistake to compare policy responses just in brute aggregate numbers. The right way to think about the scaling of policy is well, how big is the shock that the policy is responding to? So going back again, to the GFC, the financial crisis, again, on brute aggregate numbers that, that like an extraordinarily large policy response in terms of how big government deficits got, in terms of cutting interest rates down to the effective lower bound, this was the first time for many developed economies that that happened. How big central bank balance sheets got, again, the first time for many developed economies that central banks started expanding balance sheet in that way. And so on that level, it looks like extraordinary policy. And yeah, I think our analysis of policy following the financial crisis, that it was too small, that there was insufficient policy response to deal with the size of shock. And that's one reason that many countries experienced such a sluggish recovery. So even though it looked large on the brute numbers, it was actually too small. And so similarly, with with the COVID shock, I think the right way to think about it is not that these numbers are extremely big. It's the fact that the crisis, the COVID crisis was extremely large, and therefore that called out for a very big policy response. And it's quite plausible still, that it will turn out that some economies that the policy response will have been too small. I think that's a lot less likely in the US. And as we sort of touched on on previous podcast before, there is an argument that anything, the policy responses being too big out there is not a concern that we're especially worried about, but it is, I think, the distribution of risks, that it's skewed towards policy being too big, rather than being too small. And I suppose I would say that is a nice problem to have. But fpr other countries, it's just too early to tell whether the support would have been sufficiently scaled and whether we might still see support being grown earlier than we think is appropriate , and therefore, a more sluggish recovery than otherwise could have been achieved.
Yeah, we've talked before on the podcast about the scale of US stimulus, but also about prospects for say European fiscal policy, which at the moment is pretty simulative, we have hoped that it will remain stimulative. And indeed, the architecture of the European fiscal rules will be reformed to help fiscal policy remain more reactive. But of course, there are risks in the other direction as well that some economies like like the Eurozone, even perhaps the UK, repeat some of those past mistakes of withdrawing stimulus too soon. Great. So Jeremy, building on what Luke has said, a highly unusual feature of the COVID recession was that it wasn't really a typical end cycle event. It wasn't caused by an overheating economy, a breakout and inflation, a central bank tightening cycle in the way that many business cycles, and instead it was more like a completely exogenous shock. And that raises an interesting question, which is, in this recovery phase, are we now recovering into a completely new business cycle that we can expect to stretch on for many years ahead of us? Or are we back into the old mature expansion phase that we were in pre COVID? So this is the question of how long the business cycle is going to last from here. What are your thoughts on this question?
I think it's somewhere between the two. So let me explain with the example of the US labour market. So the US employment to population ratio for prime age workers is right now still about three and a half percentage points lower then it got to at the pre-COVID localised peak. And so we're around 15 months into this shock now. And so there has been a substantial cyclical knock to the US labour market and the same is true for Europe, although it's a bit milder because of the nature of the working schemes. But the point is that the labour market has been knocked off its pre COVID equilibrium. So from that standpoint, I don't think we can just say, okay, we're resetting at this point. And now it's as though it's just a continuation of the pre COVID business cycle. I don't think that would be true. However, if you compare that labour market shock, with the shock associated with the global financial crisis, and in Europe's case that the twin recession associated with the sovereign debt crisis, and the policy mistakes were made around that, it does look radically different from that standpoint. So that the level of of the US unemployment rate today is back to where it was in early 2015. In Europe's case the unemployment rate of today stands where it did in early 2000, and in 2018. So I th ink it's absolutely fair to say that the shock to the labour market has been much less severe. And so therefore, if you were to compare spare capacity, at the 15 month stage of the recovery after the financial crisis with now, the labour market is in much better condition. So assuming that you get a significant recovery, and I think it's reasonable to expect a more rapid recovery than we saw after the financial crisis, as well as, certainly, as you said, and alluded to, fewer headwinds associated with this recovery, likely, then, after the financial crisis, fewer imbalances that had to be resolved, then will likely get back to full employment more quickly. And then depending on how policymakers manage that more rapid return to full employment. And certainly, what the underlying inflation consequences turn out to be, I don't think it's unreasonable to conclude that this business cycle may turn out to be shorter.
What about the status of other typical imbalances that you have at the end of normal business cycles? Are things like excesses in the housing market? Or in bank lending? Are these... did those unwind during the shock? Or are they still at levels that we might worry about in a typical sort of late cycle period?
Again, it's interesting, because I think we argued before the crisis that those imbalances were not that great to begin with. Right? So if you look, for example, at household balance sheets, at the end of 2019, across most advanced economies, certainly the more systemic ones, withdrew some of the friction countries like Australia, New Zealand, Sweden, Canada, and that those household and corporate balance sheets, they certainly weren't as weak, as was the case in 2006 2007, and 2008. And even if you look at emerging markets, you know, we were looking at an environment where we would have argued that there were pockets of imbalances rather than major systemic imbalances. So I think from that perspective, it isn't like we then emerged into a period where now we look at the balance sheet and say: 'Well, this looks really unsustainable, this must unwind in some way.' What I think is true, though, is that this has been a leveraging event. But if you look at the ratio globally, of non financial corporate debt to GDP, the ratio of household debt to global GDP and ratio of public debt to GDP, globally, they've all increased, right? So we're not starting this cycle from a position of low leverage. Now, this can play out in a couple of ways, you could just simply constrain growth, then through this recovery, in some ways it becomes an inhibitor to demand, or equally, it might also be the case that given the nature of the policy environment, maybe new imbalances turn out to be generated, and that itself may represent a threat to the cycle later on. Don't get me wrong, I don't think we're there at the moment. And but that is plausible, that we get there. And if that occurs, then that would not only condition our view of recession risks at some point, but also the nature of the vulnerabilities when they unwind.
And one of those sort of new imbalances that we've thought of little bit about is the potential for zombie companies. So companies kept alive during the pandemic by the amount of government support, which then could be one of these post crisis imbalances that emerge. But some good reasons there to think that we're not straight back into a very late cycle regime, imminent business cycle recession. But I think some good reasons to think that it's also not going to be another 10-15 year expansion phase, like the one we live through previously. But let's move then to another unusual feature of the recovery, which is the split between manufacturing and services that typical recovery is often manufacturing led, global goods demand is highly cyclical, and manufacturing production can come back online after a downturn, very rapidly. And by contrast, the service sector is often thought of as less cyclical. How is that dynamic potentially going to be different during this recovery phase?
Yes. So it's worth saying that, in a sense, the global economy has been recovering for a year now and sort of fits and starts. And so actually, that cyclicality of the industrial sector is present in the data over the past 12 months. So what we now kind of talk about is, what the recovery looks like from here, but a gauge, a numerical example, just to make this very clear for listeners. So if you look at the profile of US real goods consumption, and real services consumption during the previous US recession, so this is the 2008-2009 recession. So peak to trough real goods consumption in the US declined by about 8% during that recession. And real services consumption barely dropped. So at the most by a percentage point, in fact, it's probably a little bit less than that, right? So you have a period where service consumption flattened off during that recession, but it never really declined. So this recession has just been radically different. So both goods and services consumption dropped initially. But then goods consumption recovered incredibly rapidly so that in the US and many other countries good consumption is now currently running well above its pre COVID trend. And whilst global industrial production hasn't recovered, as quickly as that, in part because of supply bottlenecks, it's certainly recovered much more quickly, then services production has. So what we're really doing right now is we're looking at an environment where the good consumption share globally has risen very substantially, where there's much more spare capacity in the global services sector than the global goods sector. And given the nature of the reopenings, that we're expecting, assuming that our projections for vaccination, and a reduction in the intensity of the pandemic turned out to be true, then there's just simply much more room for expansion in the global services sector. So something that we're used to thinking of is acyclical, becomes hyper cyclical on a 12 to one to 18 month horizon, and is likely to drive the recovery from here. And I think that's important that just from an economic standpoint, this also important from a market standpoint. Because when analysts think about cyclicality in markets and the type of firms that typically do really well in expansion, in some ways that cyclicality in the industrial manufacturing goods consumption side is already in the past, it's not to say it's going to substantially look worse over the next few months. But that speed of recovery is going to moderate. And so the, most of the growth is going to rotate into services into that could might mean that the pattern of equity of profits in the corporate sector and then ultimately, the the pattern of returns is also different from what we'd see in a typical recovery as well. So just marks it out, like just what we said beforehand, that this is just an extremely unusual cycle, compared to previous ones.
Great. And that's, as you say, changing what we call a cyclical stock to some extent. Yes. So Bob, turning to you, the final way in which this recovery is different, or the way in which we're going to talk about the recovery being different is the EM DM divergence that's opening up. The classic recovery is often EM, let at least that was certainly the case coming out of the financial crisis when China was the rising tide that lifted all boats of the global economy, because of its very large credit stimulus. This time around, it's Different, it's more of a DM led recovery. And there are a number of reasons why the EM recovery, at least in a relative sense is lagging behind. So let's get into those. One is China itself? Why is China not providing the huge lift to the global economy that it did coming out of the financial crisis?
Yeah, thanks, Paul. I mean, I guess there's kind of a couple of reasons spring to mind. First of all, China had a very sharp, and kind of short, sharp shock, bouncing back pretty quickly. So in that sense, it used policy stimulus in that initial stage. But now that is basically, almost back to trend growth, you're very much getting close to fully recovered, you that need to kind of keep on providing a stimulus that would be supportive, for other, EMs just kind of isn't there. And then probably the other point might be a 'careful what you wish for' scenario. After all, financial crisis, and also after the industrial slowdown that we saw around 2015-16, China threw quite a lot of stimulus, the domestic economy that spilled over internationally. But around that time, China was getting an earful from the IMF, other international organisations saying: 'Look how risky the credit bubble, credit fuel growth is, you really need to get your financial stability house in order'. And I really think it's been quite remarkable actually, that through this kind of COVID shock state bodies really held the lane on financial de-risking, I know, that's another reason why we're not seeing a repeat of the global financial crisis or that 2015-16 period I mentioned.
And, of course, the goods and services dynamic that Jeremy was talking about has implications for the relative strength of the EM, the Chinese recovery and the EM recovery as well, right?
Yeah, that's right. I mean as Germany, through their composition of growth, this time round will be, will be very different. For EM, so normally, when we get that kind of US policy, or even a kind of just general DMpickup, in growth out, there'll be things on it unambiguously good for emerging markets. But this time round we might be talking about more of a situation, where US fiscal policy is really gonna be stopping goods consumption in the US from falling. So we might not see it rise either, combined with normalisation in the share of consumption to goods and services and other developed markets. I think this really means we will see, just, we just want to see that kind of normal boost from rising GDP and developed markets through to trade and industrial production, that your sword so important, typically, for an EM, and Em current lead recovery,
Great. And then virus and vaccine dynamics, of course, key to this divergence as well. DMs have been able to secure very large pre-orders now, very large deliveries of vaccines to cover their populations, and many of them are now seeing the pandemic itself, seemingly, hopefully in abeyance. That's not the case, of course, in some high profile EMs like India, which have still having very bad viral experiences. What's the point at which you would expect the EM pandemic to be drawing to a close? I mean, is this is operating in a lag relative to DMs? Or are they going to be in the shock a long time? More?
Yeah, no, it's definitely one of the key reasons why EMs are facing this kind of longer duration shock, and making it harder to kind of catch up with DMs. The other thing is, it is now looking increasingly divergent across the EM landscape. You know, we quite often talk about EMs one kind of single aggregate. And while I think it is true that on aggregate, you have average through vaccination is lagging behind that does miss I think, some quite important differences. We've seen a very large acceleration actually, in Chinese vaccinations recently, we've got some high income emerging markets such as Chile, and Israel, sometimes even actually the Eastern European countries also seen a very marked acceleration vaccinations last few months. So you this kind of somewhat disparate group of countries, maybe operating something close to a DM timetable, in terms of vaccinations, whereas we see kind of many other regions and countries really lagging quite far behind. LatAm kind of starting to catch up from a kind of low base. We still think that herd immunity might be something more like a middle of 2022 story for much LatAm and APAC where actually, you know, they've come through the shock relatively well, your producer their ability to manage the virus Well, I think that's also taking away some of the urgency to actually get the vaccines in people's arms, combined with maybe some difficulties and actually obtaining supplies, you really are seeing much of East Asia really lagging behind on the vaccination front. I think we've seen a few kind of intrusive chinks in the armour recently, within Asia. Malaysian case numbers have been continuing to rise are looking quite concerning, getting up to the kind of daily case numbers that we're seeing in some countries in LatAm, if look at the metric, they're still at very low levels. But we have seen rises in Thailand, and Vietnam, and even some very still rises in Taiwan as well. There is more evidence, I think, that the Indian variant itself has spread to other countries within Asia. You know, given the the tragic experience we've seen in India is definitely one to watch to weather, I guess the kind of the ability to manage COVID. A well in Asia continues going going forward.
Yeah, seems like part of the slowness of vaccine rollout in Asia is itself a legacy of previous successes in containing the virus itself. And perhaps that lent a bit less urgency to vaccine rollout there. And why by contrast, some of the rich DMs that did so poorly in the initial waves were amongst the fastest in in vaccine rollout as well. So then, a final dynamic is, is what's going on with monetary and fiscal policy. So a lot of DMs are still running extremely supportive monetary and fiscal stances. The US potently so when it comes to fiscal policy. But I think European fiscal policy is going to remain fairly supportive for a little while yet as well. And although the Fed in the US is talking about talk, talking about tapering asset purchases, for now, monetary policy settings, I think are very accommodative and supportive. Why is that increasingly less the case in EM? So why are some EM governments turning towards more austere fiscal policies? And why is there beginning of a rate hiking cycle amongst some emerging market central banks?
Yeah, I mean, somewhat, some of it, of course, goes back to what we were discussing before, while US fiscal policy is, is kind of good, obviously, for boosting the economy, for EMs of course, also tightening financial conditions, and combined with this lagged effect, this rotation in the composition of demand away from goods, that's probably tightening financial conditions, a bit more in emerging markets would have done otherwise, also had very strong commodity price rises, combined with base effects on inflation coming off, is that combination of going higher US yields rising headline inflation is just really made the policy challenge for emerging market central banks much more difficult, much harder to kind of look through those pressures. I think that's definitely been tough. Part of the reason why we've seen a couple less supportive stance from emerging markets, but I don't think that's the full story as well. To the extent that we can disentangle it. Probably the domestic backdrop has become much less supportive. In many countries, we're just not really seeing policy flex with the viral trends in this very good example there, where the additional fiscal spending was coming through, despite this massive second wave and tragic cost in human life, as well has being very, very minimal. And this is really, I think, for many countries, quite stark contrast 2020 policy and EM to relatively unconstrained. I think, in many ways, it's kind of like slightly later, maybe slightly smaller version of DM policy. But we're moving into a much more constrained world. I do think there maybe has been a little bit of a failure by policymakers to make fiscal and fiscal in particular, but also monetary policy, a bit more kind of state contingent, in 2021. For many countries, particularly where we're still seeing quite good trade balances, and also depressed private sector is not clear that fiscal policy couldn't have done more. So I think some of this reflects kind of fears about spooking the markets or rising risk premium, but also just kind of domestic, the domestic political situation as well. So I think as a region LatAm really stands out here, where we've clearly seen continued very high case numbers, but fiscal policy is very much been in kind of retrenchment mode. In contrast, a probably see that fiscal policy in Asia has been more neutral, more supportive, with respect well, excluding India. So you just mentioned earlier
Brilliant. Well, Luke, Jeremy, Bob, thank you very much for stepping us through why this recovery is different. That's about all we have time for this week on the podcast. Thank you for listening. Remember that we have a mailbox email@example.com if you'd like to get in touch, and don't forget to like or subscribe on your podcast platform. But until next time, goodbye and good luck out there.
Please note that email is not a secure form of communication, so don't send any personal or sensitive information. This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only, and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication, and do not necessarily reflect those of Aberdeen Standard Investments. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections are estimates and provide no guarantee of future results.