If we consider the latest official publications, the US Federal Reserve (Fed) still has some time to wait, as the most recent US jobs report showed stagnation in the creation of jobs over the month of April. This could justify a posteriori Jerome Powell’s decision to prioritise employment over inflation in setting the Fed’s monetary policy.
However, if we look at US inflation in April, we are already at the highest level in the past several years in terms of monthly inflation growth, even after adjusting for the base effect linked to energy, which inevitably and a minima raises the question of the Fed ending its asset purchases. Households’ inflation expectations are also on the rise, reflecting the strong sensitivity to gas pump prices as well as the inflation present in many consumer goods segments. All these signals justify a discussion in the coming months of a tapering of the Fed's asset purchases, which could start in early 2022. However, short term rates should remain at their current level until the start of the following year.
This question is emerging in a highly particular year of growth during which the coordinated recovery of the main Western countries must help to end the recession and underemployment as quickly as possible. Everything depends on what “quickly” means: a few months or quarters in the United States, and probably a few years in the Euro Area, where the implementation of the recovery plan has been slow. This is an important question for currencies in the second half of the year: will the end of lockdowns and the recovery plan bring European growth up to the dynamic level seen in the United States?
And yet, increasing public spending is not the path to long term economic growth, and may even hamper it, unless this spending is focused on investments (infrastructure, digital, education, etc.) and accompanied by reforms aiming to boost economic productivity.
It is no coincidence, then, that the Biden govern-ment’s response in the US, like that of European governments, has been focused on investments. It is also interesting to note that in this context, Italy seems to want to take advantage of this phase to initiate reforms of organisations aimed at improving its productivity, which has continued to lag behind that of its European neighbours.
But should we fear a fiscal slowdown in 2022, after a highly monetary 2020 and a 2021 marked by budgetary recovery? In any case, it would be logical to anticipate that the corporate tax rate (which has sharply decreased over the past four decades) would be increased to contribute to financing a return of the welfare state that came under attack in the 1980s. This was the essence of Janet Yellen’s remarks at the most recent International Monetary Fund (IMF) summit. The challenge will be to find a sustainable balance in government financing methods in an increasingly dual economy, as digital disruption grows.
One thing seems certain: governments cannot sustainably increase their spending and, at the same time, continue to lower tax rates, without endangering their long term recovery trajectories. Potential growth and innovation remain the long term objectives of these plans, and the 2022-2023 growth trajectory will likely act as a test for these recovery plans’ effectiveness.
Against this backdrop, beyond the recovery of Cyclical and Value sectors that should continue this year, Schumpeterian growth1 could again dominate Keynesian growth2 and investors could continue to prioritise countries and actors driven by innovation and sustainable growth, perhaps to the detriment of Cyclical sectors and countries whose growth model is based too strongly on the accumulation of debt. Following this cyclical recovery that should extend to all countries in the second half of the year, we may find more divergence next year.
1- Schumpeterian growth: growth model characterised by the focus on technological progress and productivity gains.
2- Keynesian growth: growth model characterised by government interventionism via the implementation of contra-cyclical recovery measures in order to support demand during periods of undesired downturn in activity.
Monthly House View, 25/05/2021 release - Excerpt of the Editorial
May 31, 2021