The great Covid-19 race

Race to the post Covid-19 recovery: 7 obstacles to overcome 

01 April 2021 

Executive summary

  • The global recovery is on the right track albeit conditional on key differentiating elements across countries. Global GDP is expected to rebound by +5.1% in 2021, with one fourth of the recovery being driven by the US, while China should contribute less to growth by progressively adopting a less accommodative economic policy. In 2022, world GDP growth should reach +4.0%. Europe should recover its Covid-19 losses only at this horizon against H2 2021 for the US. The race to recovery will hinge on seven key obstacles.
  • Obstacle 1: Formula 1 race on vaccination. Execution risks will remain a key differentiator between countries, with the pace of vaccination campaigns driving a multi-speed recovery and keeping divergence at high levels. At the current pace of vaccination, the US and the UK will reach herd immunity in May. While Europe should be able to vaccinate its vulnerable population by the summer, herd immunity is not likely to be reached before the fall at the current pace. On the other hand, most governments (France) are speeding up the vaccination pace to reach herd immunity during the summer.
  • Obstacle 2: Excess savings will still hover around 40% above pre-crisis levels at end-2021. In a relatively optimistic scenario, excess savings from households should provide a tailwind to consumer spending to the tune of +1.5% of GDP in Europe and more than +3% in the US in 2021. Close to the same amount could be added on top for investment or consumption abroad purposes should confidence effects play a positive role. We calculate that around EUR163bn could be transformed into private consumption in the Eurozone, equivalent to 30% of the Covid-19 excess savings. However, in the US, we expect 50% of the current excess savings to be spent in 2021 as an earlier loosening of restrictions and more powerful fiscal impulses should boost the confidence effect. The US household savings rate should be back to a normal level at close to 7% of gross disposable income at end-2021.
  • Obstacle 3: Phasing out assistance mechanisms is not a zero-sum game and the risk of  policy mistakes remains high. After the “whatever it takes” consensus in 2020, fiscal policy will march to the beat of national drums going forward. In 2021, the consensus to do “whatever it takes” is already giving way to more heterogeneous policy prospects. In China, the path towards a fiscal normalization has already started, with fiscal targets implying a clear withdrawal of policy support in 2021, even if some flexibility will be kept to manage credit risk if needed. The global demand torch will pass to the US, with its gigantic USD1.9trn fiscal stimulus (9% of GDP). Europe's fiscal response pales in comparison: the Next Generation (NGEU) fund will only extend a helping hand from H2 2021 onwards and the growth impact (a cumulative +1.5pp until 2025) should prove moderate and delayed, given its focus on the supply side – 2/3 of the EUR313bn grants are likely to be used for investment – and drawn-out payments.
  • Obstacle 4: Crowding-in vs. crowding-out effects on investment are not yet resolved. Joe Biden’s “Build Back Better” in the US (potentially USD2.3trn), the EU Next Generation of EUR725bn fund and China’s infrastructure plan totaling more than YUD1.5trn by 2025 will all contribute to support demand and the global economy’s growth potential over the medium-term. But their success depends on whether governments can channel excess savings to productive projects and boost private sector. We find that EUR100bn of excess savings could increase business investment by around +2% y/y in Germany, France and the UK, but much of this will depend on future tax policies and the funding conditions (e.g. recovery state-guaranteed loans).
  • Obstacle 5: Bottlenecks in the global supply chain are as high as during the peak of the pandemic and should push global trade into a borderline recession in Q2. Global trade growth will rebound to +7.9% in 2021 in volume terms, but excluding the positive base effects from 2020 growth will stand at +5.4%. More importantly, we expect a temporary slowdown in Q2 2021 due to prevailing supply-chain disruption: for the full year 2021, we estimate that the impact of supply-chain disruptions could weigh on global trade growth by -1.7pp. In addition, trade in services will remain impaired by the delayed reopening of sectors most impacted by Covid-19-restrictions and continued barriers to cross-border travel.
  • Obstacle 6: Temporary overshoot of inflation. A temporary overshoot of inflation is likely to be driven by temporary base effects. Hence, companies’ pricing power is likely to remain limited, given subdued demand dynamics: (i) excess savings from households and NFCs that act as a drag on money velocity; (ii) persistently negative output gaps due to lower capacity utilization and (iii) rising unemployment rates that will keep a lid on wage growth (below 3%). Therefore, we don’t expect central banks to stage a policy U-turn as a reaction to inflation temporarily overshooting in the US at 3.5% by mid-2021 and hitting the 2% target for a few months in the Eurozone.
  • Obstacle 7: Not putting an end to the sweet music of market’s reflation. Risky assets are operating under the assumption that what is good for them – unconventional monetary policy and fiscal profligacy – is necessarily good for the real economy, which will ultimately validate their optimism. For the time being, however, what we see is a widening divergence between asset prices and their underlying value. Amplified by various investment management techniques (ETFs, risk-parity) that put asset allocation on automatic pilot, this divergence is a vulnerability. An inadvertent escalation in geopolitical tensions between the US and China, surging inflation that wrong-foots the subdued inflation expectations held by central banks or nationalistic impulses prevailing over the common good in Europe are all exogenous triggers that could put its widening in reverse. But exogenous sources of risk are always easier to identify than endogenous ones: the danger is more likely to come from within capital markets. As shown by the rise of options trading and margin debt, leveraged investing is pervasive, and so is the confusion about liquidity: especially in capital markets, the velocity of money (the flow of liquidity) is far more volatile than its quantity (the stock of liquidity). In the presence of leverage and overtrading, risk-taking is prone to running amok and even a minor shock to confidence can lead to a sudden drying up of liquidity, forced liquidations and/or default. 

From China saving the world to the US. Global GDP is expected to rebound by +5.1% in 2021, with one fourth of the recovery being driven by the US, while China should progressively adopt a less accommodative economic policy. In 2022, world GDP growth should reach +4%. The over-expansionary stance of the global policy mix explains this rebound in 2021 and 2022, compared with the contraction of –3.6% in 2020. However, execution risks will remain a key differentiator between countries, with the pace of vaccination campaigns driving a multi-speed recovery and keeping divergence at high levels.

Obstacle 1: Formula 1 race on vaccination. At the current pace of vaccination, the US and the UK will reach herd immunity in May (see Figure 1). While Europe should be able to vaccinate its vulnerable population by the summer, herd immunity is not likely to be reached before the fall at the current pace of vaccination. Overall, the seven weeks of vaccination delay in Europe is equivalent to EUR123bn of economic losses (see Figure 2), or more than twice as much as the EU Generation Fund’s planned disbursement for 2021. Asymmetries will be also be the result of dis-synchronized economic policies. The US will remain at the forefront of fiscal initiatives, while delays in execution will be visible in Europe. The early positioning of China in the current cycle will allow the central government and the PBoC to start a reining in of their expansionary policies.

Figure 1: Expected date of herd immunity

Sources: Our World in Data, Duke University, Euler Hermes, Allianz Research
Figure 2: Cost of vaccination delay
Sources: Our World in Data, Duke University, Euler Hermes, Allianz Research
Obstacle 2: Excess savings will still hover around 40% above pre-crisis levels at end-2021. Excess savings from households should provide a tailwind to economic growth to the tune of +1.5% of GDP in Europe and more than +3% in the US in 2021. In 2020, Eurozone household savings increased by EUR530bn or +40% compared to pre-pandemic levels. Out of this, and taking into account the pace of dissaving from 2020 during de-confinement periods, we expect EUR180bn to be unleased in 2021 in the Eurozone, equivalent to 1.5% of GDP (see Figure 3). At end 2021, this would mean a fall of a bit more than 50% in excess savings compared to end-2020. Looking at the structure of savings by income level and the propensity to spend, we calculate that around EUR163bn could be transformed into private consumption, equivalent to 30% of the Covid-19 household excess savings, and to half of the depleted household savings in 2021. This is equivalent to around half a point of GDP this year. Overall, at end-2021, we expect Eurozone savings to still remain 37% above pre-pandemic levels (or close to EUR350bn, 2.9% of GDP). In the US, we expect 50% of the current excess saving to be spent in 2021 as an earlier loosening of restrictions and more powerful fiscal impulses should boost the confidence effect. The US household savings rate should be back to a normal level at close to 7% of gross disposable income at end 2021.

Figure 3: US and European households’ savings, % of GDP (expected unleashed in 2021)
Sources: : FRED, Eurostat, Euler Hermes, Allianz Research
Obstacle 3: Phasing out assistance mechanisms is not a zero-sum game and the risk of  policy mistakes remains high. In 2020, unprecedented monetary and fiscal stimuli to the tune of 20% of GDP helped cushion the economic blow to global GDP. By early 2021, the consensus to do “whatever it takes” is giving way to more heterogeneous policy prospects. In China, for instance, policy stimulus has already passed its zenith in line with the advanced economic recovery. In fact, the path towards policy normalization has already started, with official targets implying a clear withdrawal of policy support in 2021, even if some flexibility will be kept to manage credit risk if needed. The global demand torch will pass to the US, where the gigantic fiscal stimulus to the tune of USD1.9tn (9% of GDP) will provide a much-welcomed boost to global exports (USD362bn in 2021-2022, 2% of total nominal trade).
 
Europe, meanwhile, has learned from its 2011-12 policy mistakes, when it pursued a pro-cyclical fiscal stance, but its Covid-19 fiscal response still pales in comparison to the US. On the surface, the story is one of the US doubling down with an unprecedented fiscal bazooka at a time when a recovery is already starting to unfold, while Europe has spent all its political capital on a stimulus that is too small, too drawn-out and subject to heightened implementation risk. However, headline figures are deceiving: we estimate Europe’s stimulus to be closer to 2/3 of the US response when factoring in automatic stabilizers in 2020-21 (see Figure 4). For now, national fiscal policy continues to lead the show in Europe via ongoing targeted support measures aimed at keeping a lid on economic scarring i.e. job retention schemes, transfers to the most impacted sectors and public credit guarantees. We expect most EU flagship fiscal policies to be phased out no sooner than fall 2021, given the delayed recovery prospects, which is bound to trigger a rise in unemployment and insolvencies. Fiscal stimulus may even surprise on the upside as Eurozone governments underspent in 2020, as the sharp rise in government deposits suggests (we estimate excess deposits at 3% of GDP). The EU’s Next Generation fund will only extend a helping hand from H2 2021 onwards and the growth impact (a cumulative 1.5pp until 2025) should prove moderate and delayed, given its focus on the supply side – 2/3 of the EUR313bn grants are likely to be used for investment – and drawn-out payments. Nevertheless, with NGEU funds not counted under national deficits, they will help cushion the normalization of fiscal policy. This is particularly true for recovery laggards, including Spain and Italy. In any case, we expect EU fiscal rules to remain suspended until 2023.
 
Most countries will continue to inject liquidity and support companies and jobs to avoid the sanitary and economic crisis morphing into a financial and social crisis. Hence, the risk of policy mistakes is high, negative externalities are visible (disconnect between financial markets and the real economy; lack of price for credit risk, inequalities) and rolling back state and central banks’ support will prove complicated. The risks are further protectionism, disorderly exists (taper tantrum for example), scarring effects (private debt levels) and more entropy across countries (especially as the political calendar is heavy in Europe).
 
2022 will bring an (economic) reality check for companies. Higher interest charges for non-financial corporates are likely from next year onwards and we forecast a cumulated impact of close to -2pp at end-2023 for Eurozone NFCs’ margins on average. An increase of low bank interest rates offered by the state-guaranteed loans will push NFC interest payments on the upside as soon as 2022. An incremental increase of at least +50bp per year for the new loans given in 2020 is expected and would be equivalent to an increase of close to close to EUR15bn in the Eurozone as a whole or a rise of +0.8pp of the operating surplus to close to 4%. In terms of the impact on NFC margins, for the Eurozone countries on average it would go from -0.3pp in 2022 to close to -2pp in 2023. The impact is expected to be above Eurozone average in Belgium, Italy and Spain. Another credit market risk: corporate bond redemptions will increase by more than 70% in 2022 and double in the US.

Figure 4: Fiscal deficit, % of GDP
Sources: Various, Euler Hermes, Allianz Research
Obstacle 4: Crowding-in vs. crowding-out effects on investment are not yet resolved. The multiple initiatives in terms of infrastructure projects, including Joe Biden’s “Build Back Better” in the US (potentially USD2.3trn), the Next Generation EU EUR725bn fund and China’s infrastructure plan totaling more than USD1.5trn by 2025, will all contribute to support demand and the global economy’s growth potential over the medium-term (see Figure 5). In this respect, their success will also rely on the efficacy of governments in channeling excess savings to productive projects. In addition to potential growth, we estimate that in advanced economies, households’ financial assets (i.e. excess savings) are a key long-term determinant of the investment cycle (see Figure 6). The positive impact of excess savings on the durability and the magnitude of the new investment cycle is significant in the US,  Germany, France and the UK.

Besides the question of capital allocation, tax policies will also play a decisive role in funding these long-term projects. In the US, Biden’s administration aims at increasing the corporate income tax from 21% to 28% and taxes on capital gains and the incomes of the wealthiest households. One of the probable long-term legacies of the Covid-19 crisis, alongside the significant jump in public debt, relates to a probable redefinition of the value-added sharing, less in favor of profits and more in favor of salaries.  The long-term success of the new upcoming investment cycle will certainly hinge on the progressiveness of these new fiscal orientations.
 
Figure 5 - Infrastructure spending vs. estimated gap, % of GDP
Sources: Various, Euler Hermes, Allianz Research
Figure 6 - Increase of working capital requirements and tax deferrals vs. NFC “excess cash”, bn LCU, as of Feb. 2021
Sources: Various, Euler Hermes, Allianz Research
Obstacle 5: Bottlenecks in the global supply chain are as high as during the peak of the pandemic and should push global trade into a borderline recession in Q2. Global trade growth will rebound to +7.9% in 2021 (+5.4% excluding positive carryover effects from 2020) and +6.0% in 2022 in volume terms, but a temporary slowdown is expected in Q2 2021 due to prevailing supply-chain disruption (estimated to cut 2021 volume growth of global trade in goods by -1.7pp). Trade in services will remain impaired by the delayed reopening of sectors most impacted by Covid-19-restrictions and continued barriers to cross-border travel. In 2020, trade in goods fell by -8.1% in volume terms and -10.8% in value terms. This was less than previously expected, thanks to the rapid recovery in Asia and China. However, the temporary supply-chain disruptions in H1 2021 (container shortages, higher transportation costs, shortages of some inputs such as semiconductors and raw materials, as well as the temporary blockage of the Suez Canal) are likely to slow the flow of trade in goods. More specifically, we expect sequential growth in trade to be only slightly positive in Q2 2021 and at risk of turning negative if disruptions linger. For the full year 2021, we estimate that the impact of supply-chain disruptions could weigh on global trade growth by -1.4pp, and by -0.3pp for the one week of immobilization in the Suez Canal. On the positive side, positive carryover effects should boost global trade growth by +2.5pp more than previously expected, while the US super stimulus and other recovery factors could add +1.3pp. Overall, we expect global trade to grow by +7.9% in 2021 in volume terms (see Figures 7 & 8 and here for more details). In value terms, strong price and currency effects should push growth to +14.2% in 2021.

Figure 7 - Global trade growth, goods and services, % y/y
Sources: IHS Markit, Euler Hermes, Allianz Research

Figure 8 - 2021 global trade forecast, % y/y

Sources: IHS Markit, Euler Hermes, Allianz Research
Obstacle 6: Temporary overshoot of inflation. Inflationary pressures will continue to increase notably in 2021, thanks to (i) the recent input cost bonanza, driven above all by strained supply chains and the oil price recovery; (ii) higher services inflation along with the economic reopening in H2 and (iii) strong pandemic-related roller coaster base effects. But we do not see inflation embarking on structural upside trend as subdued demand dynamics point to a potential head fake: (i) excess savings from households and NFCs that act as a drag on money velocity; (ii) persistently negative output gaps due to lower capacity utilization and (iii) rising unemployment rates will keep a lid on wage growth (below 3%). Therefore, we don’t expect central banks to stage a policy U-turn as a reaction to inflation temporarily overshooting in the US at 3.5% by mid-2021 and hitting the 2% target for a few months in the Eurozone (see Figure 9).
In fact, we expect policy normalization to proceed at a very gradual pace in the US, kicking off with a first tapering step in H2 2022, while China will take credit growth lower very gradually. Meanwhile, the ECB will continue to “walk the talk” in 2021 by boosting the pace of asset purchases made under the PEPP in line with its stepped-up verbal intervention to protect favorable financing conditions. In 2022, the ECB may get away with a slower pace of monthly QE purchases without endangering the strengthening recovery but in terms of active normalization steps it will clearly lag the Fed as inflation will remain subdued at 1.2% in 2022 after 1.4% in 2021. In contrast, in many Emerging Markets, inflation has already staged a meaningful comeback, which central banks are unlikely to ignore. In Africa, countries such as Angola, Ethiopia, Nigeria and Zambia now boast double-digit inflation rates because of FX depreciations and food shortages. In LatAm, we see Brazil most at risk, with high input price pressures driven by supply-chain disruptions and FX depreciation now passing through to CPI. Inflation in Turkey, the Philippines and India have also exceeded central bank targets.

Figure 9: Central bank’s balance sheets (Index Jan2005=100)
Sources: IHS Markit, Euler Hermes, Allianz Research
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