Q2 2021 Global Economic Outlook

Quick takes:

• Economy poised for generational growth
• Inflation ticking up
• Pervasive labor scarcity
• U.S. economy key driver of global growth
• U.S. CRE market participants need to be prepared

Generational growth

The global economy is roaring back to life in 2021. After suffering the worst downturn in at least 40 years in 2020, the global economy has begun clawing its way back this year. While first quarter global growth remains preliminary, data and modelling suggest that the economy grew at roughly 2.5% on an annualized basis in the first quarter of this year. Though both fiscal and monetary policy remain supportive of economic growth, the economic restart stems predominantly from changes on both the supply side and the demand side of the private sector of the economy. On the supply side, declining case levels in some countries allowed governments around the world to relax strictures that limited the ability of businesses to operate at or near full capacity. Consequently, production in the economy has increased, boosting economic growth. On the demand side, as consumers in certain economies felt safer venturing out, they have increasingly returned to economic activities they actively shunned during 2020 while also resuming more typical spending patterns. 

That feeling of safety stems from a lessening pandemic and diminished perception of risk. Thus far that has originated from two key sources: (1) vaccination, which began rolling out in earnest in the first quarter (2) via countries bringing the pandemic under control without vaccination by diligently utilizing measures such as social distancing, masking, controlling ingress to the country, better treatment and care of the infected, etc. This process, of course, has not occurred in a uniform manner. Most countries continued to struggle to bring the pandemic under control during the first quarter. But the global economy benefitted from several of the largest economies falling into one of the two categories above. Therefore, the growth dynamic during the quarter appears one of depth, not breadth. Growth in several large economies pushed global growth into positive territory, but many individual economies continued to contract without access to vaccination or without the ability to effectively use non-vaccine measures.

Consequently, the timing of the global economic restart has varied across economies.  Relatively few economies restarted growth in the first quarter. More will undergo this process in the second and third quarters of this year as they largely move past the pandemic, and some number will lag, with growth not showing in the data until late 2021 or even early 2022. This process will distribute individual economies’ impact on growth in the global economy across time periods, effectively elongating the process of a full global restart. Nonetheless, we expect the strongest growth during this cycle to occur during the second quarter as the relatively few economies that began the reopening process during the first quarter (namely very large economies) accelerate as they are further along in reopening. Meanwhile, several other important economies should see growth resume in the second quarter. Although the second quarter should represent the high watermark for this cycle, momentum should spill into the latter half of the year. That should ultimately drive calendar-year growth in 2021 to its highest level in at least 40 years. 

Inflation and interest rates

Although both the supply and demand side of the economy are growing once again, they are not expanding at the same rate. Generally, demand has grown faster. Pandemic control, via vaccination or otherwise, has caused demand in some economies to increase at a rapid pace. In such economies, consumers are eager to spend money when they feel safe doing so. But a similarly rapid rebound has not occurred on the supply side of the economy. It always proves easier to take production offline than to bring it back online for a variety of reasons including the permanent elimination of jobs or companies; the friction associated with hiring individuals; concerns over returning to work (especially in areas with low levels of vaccination); etc. With demand expanding faster than supply, the price level in the global economy has increased, particularly in the U.S., where relatively rapid vaccination coupled with government policy are driving demand growth. Yet the specific set of factors driving inflation in the U.S. do not appear universal, particularly fiscal policy, where the U.S. remains a clear outlier during this cycle. Nonetheless, several other countries are experiencing inflationary pressures as their economies restart. In most economies (including the global economy) we do not expect inflation to rise to levels recently observed in the U.S., but we do expect inflation this cycle to stabilize at levels above those from the last business cycle.  

Yet the implications of accelerating economic growth and rising inflation for interest rates remain unclear. Conventional theory says that accelerating inflation and growth (which are often correlated) should result in higher rates. And that has occurred in some parts of the world. Yet in the U.S., arguably the leader on inflation (or at least inflation concerns), long-term interest rates have declined since earlier in the year. Some of this appears to stem from a recognition that the U.S. economy is not headed for hyperinflation. But some likely stems from the fact that economic growth this cycle will almost surely peak this year before easing. In the medium run, interest rates are almost certainly headed higher, but some markets likely got ahead of themselves earlier this year.

Widespread labor scarcity

One of the key factors driving inflation concerns, labor scarcity, appears pervasive. In the U.S., open but unfilled jobs recently reached 9.2 million, the highest figure on record. In the U.K., a variety of industries are enduring worker shortages. A variety of Australian and Canadian firms report difficulty finding workers to fill vacancies. And even in certain developing nations, such as China and eastern Europe, some companies are struggling to hire workers. Some of this shortage appears cyclical, some of it structural. A portion of the phenomena should prove transitory: some workers are waiting until vaccinations increase to return to certain professions, some have relocated, etc. But some of the shortage is clearly structural and existed before the pandemic. The baby boomer exodus from the workforce is clearly contributing to worker shortages in many countries. No panacea exists for this issue, which is one of the reasons why inflation should likely settle in a range above the what occurred last cycle. 

Regional view

In the U.S., the economy got off to a strong start with first quarter growth registering 6.4% on an annualized basis. Although second-quarter figures are not yet available, the strongest growth is expected to occur during that period, tracking with the global economy. With that magnitude of growth, the largest economy in the world will contribute much to global economic growth. The U.S. economy remains on course for its strongest growth in nearly 40 years. Canada looks set to produce growth for 2021 on par with the U.S., due in large part to the strong showing in the second quarter as vaccinations increase and the economy more fully reopens. 

In Asia, China and India remain on track to outperform all other large economies, but the timing of their recoveries slightly differ. China’s ability to bring the pandemic under control even before vaccination began occurring enabled it to produce its breakout during the first quarter. India, hard hit by the delta variant of the coronavirus, should see its breakout occur during the second quarter. Asia’s second-largest economy, Japan, continues to grapple with the pandemic amidst low vaccination rates, but should see growth accelerate in the summer months, though benefits from the Summer Olympics should be limited due to pandemic-related restrictions. 

In Europe, lockdowns earlier in the year, aimed at slowing the spread of variants, restrained first quarter growth. Yet with vaccinations increasing, the major economies of Europe – Germany, the U.K., France, and Italy – sit poised for breakouts during the second quarter. The sheer size of their individual economies, with all four ranked in the top 10 globally, means that breakout growth should provide a meaningful boost to global GDP during the second quarter. 

Outlook and implications for the U.S.

The global economy is not out of the woods just yet. Vaccination remains uneven across countries, creating a wide rift in performance in the short run. More contagious variants pose a significant risk to economies where the population remains largely unvaccinated. Inflation, which seems transitory thus far, could be disruptive in the short run until supply-side issues get resolved. And labor shortages, more than just a temporary dislocation, should produce some drag on economic growth even though it should not produce an outright impediment. Yet despite these challenges, growth in 2021 should almost certainly surpass any calendar year for at least 40 years, creating improvements in standards of living and more abundant opportunities. 

The U.S. economy remains poised for a banner year. As one of the economies leading the global recovery, the environment is already improving. By the end of the second quarter, GDP should exceed its previous peak from the fourth quarter of 2019. Even concerns over inflation and labor shortages reflect strength in the economy, not weakness. And the rapidly evolving situation suggests that commercial real estate (CRE) market participants should at least start thinking about key decisions, even if they are unwilling to make them. The last time the economy grew this quickly, back in 1984, the structure of the CRE market differed greatly from that of today. Underdeveloped capital and securities markets, along with a more limited investor base (namely select, large institutions and high-net-worth individuals) afforded market participants more time to make decisions back then. Today, the increased efficiency of the asset class, coupled with greater integration of CRE into the broader economy and capital markets, mean that participants have less time to make decisions. Market participants have not seen this kind of economic growth in a generation – they should take great pains to avoid getting caught flat footed by its rapid recovery.