Coronavirus recovery: strong growth and low interest rates set to drive global resurgence

After a year of restricted economic activity, the level of pent-up demand is huge as people, firms and governments have piles of cash to spend
High nominal GDP growth and low interest rates cannot coexist forever, but the combination will be a boon to equity markets in the short term

Chris Iggo

Published: 3:30am, 11 Mar 2021

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The theme of reflation continues to dominate financial markets. Economists expect significant increases in the pace of economic growth later this year. This, of course, is in response to the lifting of lockdowns and social mobility restrictions as the widespread deployment of Covid-19 vaccinations brings infection and mortality rates down and reduces the pressure on public health systems.

After a year of restricted economic activity, the level of pent-up demand is huge. Savings rates have increased as consumers have been starved of opportunities to spend on dining out, entertainment and travel. Firms also have lots of cash and could start to invest it to take advantage of strong growth, boosting jobs and incomes as they do. Governments have also been busy spending money to support jobs and incomes. In many countries, they continue to do so.

All of this, plus the natural tendency of economic activity to bounce back, will mean some eye-watering growth rates in the second half of 2021. The economies that did a good job in managing the pandemic have been able to open up already and are seeing the benefit in stronger growth rates.

Last week, Australia recorded its second consecutive quarterly GDP growth rate of more than 3 per cent. China’s growth rate in the final quarter of 2020 was 6.5 per cent, and consensus forecasts for Chinese GDP growth this year are around 8 per cent. Forecasts of annualised growth rates of around 6 per cent for the US in the second half of the year are common. Little wonder, then, that equity investors remain bullish.

These are growth rates for real GDP. When we consider expectations for rising inflation, the combined growth of nominal, or current US dollar, GDP is going to be something we have not seen since the 1980s.

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Most people working today in financial markets have not seen growth so strong. They are told that rising growth and inflation leads to higher interest rates as central banks attempt to slow things down. Today, that might not be the case. Central banks are happy to let their economies run hot for the time being.

Markets are struggling with that. Long-term bond yields have risen in recent months. This makes sense, given the expected increase in nominal GDP growth. It used to be the case that long bond yield levels sort of tracked nominal GDP. That relationship broke down following the 2008 global financial crisis and the use of quantitative easing as the primary tool for monetary policy as central banks were able to repress long-term yields.

Concerns about secular stagnation and low neutral interest rates also played into the story. Many a bond investor has been frustrated in recent years, betting that yields would rise in periods of strong economic growth. Yields trended down, hitting their recent lows in the summer of last year.

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High nominal GDP growth and low interest rates cannot coexist forever. There will be a normalisation of monetary policy at some point in the next few years. Timing is critical for investors, and what we are seeing is bond investors starting to hedge their bets.

No one seriously believes the US Federal Reserve will raise rates this year or in early 2022 but, beyond that, conviction in rates being low forever fades quickly. That is now being reflected in the US and other yield curves.

For now, policymakers are happy with the growth outlook. It will help recover incomes and jobs. The fiscal stimulus that is helping the recovery will continue – note that US President Joe Biden’s first fiscal package was approved by Congress. This is doing more good to the economic outlook than the rise in interest rates is hurting it.

So, we should probably expect rates to move gradually higher, with central banks doing the job of smoothing the moves and reassuring markets that they continue to support economic growth. Consensus forecasts suggest the expansion will continue strongly into 2022.

It is hard to find a period in history with such strong growth and low rates. The combination should continue to be very positive for equity markets.

Chris Iggo is the chief investment officer for core investments with AXA Investment Managers

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