2021 Global Economic Outlook
Geopolitical insights: Thomas Mucha, Geopolitical Strategist
Macro insights: John Butler, Macro Strategist
Views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional or institutional investors only.
A great-power world
Geopolitics will remain an important feature of markets and macroeconomics in 2021, but barring a “bolt from the blue” surprise, domestic policy matters – particularly COVID-19 management and economic recovery – will dominate political agendas in Washington, DC and globally.
Against this backdrop, here are my expectations for five key areas across the geopolitical landscape.
Biden administration foreign policy – great-power competition in a multipolar world
Great-power competition will drive the Biden administration’s foreign policy, as it did under the Trump administration. But this will look different, at least in style, as the Biden team will emphasize greater coordination with US allies, particularly in Europe.
President-elect Joe Biden will also attempt to restore US leadership across a variety of multinational institutions, including the World Health Organization, the World Trade Organization, and NATO.
But while much of the globe will welcome US reengagement, this strategy will not be easy to achieve, for two important reasons.
First, the US State Department saw significant personnel losses over the past four years, among experienced professional diplomats, and regional and subject experts who craft the nuts and bolts of US foreign policy. Rebuilding US diplomatic capacity will take time.
Second, the levels of trust that America’s allies have in the US are at decades-long lows – a fact that one election is unlikely to correct any time soon.
US withdrawals from the Paris Agreement on climate and the Trans-Pacific Partnership trade deal, the scrapping of the Joint Comprehensive Plan of Action with Iran, an activist trade tariff agenda, and other fractious aspects of an “America First” foreign policy have strained relations with key allies, while weakening US geopolitical leadership, and ultimately, influence.
All of this will likely keep the world on a path of increasing multipolarity and deepening great-power competition – a difficult structural backdrop to manage in 2021 and beyond.
US-China relations — better, but not without friction
The most important geopolitical dynamic to watch in 2021, of course, will be the US approach to China.
Here I expect some improvement, as the Biden administration is likely to prioritize professional diplomacy over reciprocal tariffs. Or, put simply, expect more talking and less tweeting.
This will help pull the US and China out of their current diplomatic tailspin, and from a market perspective, will likely restore greater policy predictability. This easing of bilateral tensions will also reduce geopolitical risk in Asia and elsewhere – another market and macro positive in 2021.
But the broad outlines of the deteriorating US-China relationship – rooted in national security concerns amid rising competition – will remain firmly in place in 2021 and, indeed, will shape geopolitics for years to come.
We should therefore expect supply-chain decoupling in industries deemed “strategic” to this ongoing great-power dynamic – leading with technology, but also encompassing health care and biotech in a post-COVID world. We can expect a similar dynamic in capital markets, finance, and other industries that drive national economic and military power.
Another important difference from the previous four years will be an increased focus on human rights and democracy, which will shape US foreign policy to a much greater extent.
Working with allies in a US-led “coalition of democracies” will spark additional geopolitical friction with China in 2021, particularly in Xinjiang where Beijing’s Uighur policy will be a focus, as well as in Hong Kong given recent developments, and in Taiwan, which is likely to be in the crosshairs of the emerging ideological split between China and the West.
An opportunity on climate — but fragmentation makes this a tall order
Climate change – the biggest threat to US national security and geopolitical stability over the long run – will be a significant US policy focus in 2021.
The Biden administration will immediately return the US to the Paris Agreement, and we should expect a series of executive actions by President-elect Biden to limit fossil-fuel drilling, strengthen environmental protections, and broadly speaking, reregulate the US energy industry.
At the global level, climate also presents an opportunity for the US and China to find mutual areas of agreement, another potential positive for bilateral relations.
But, again, great-power competition and a more multipolar world will present challenges for climate cooperation.
The world’s four largest CO2-emitting countries – China, the US, India, and Russia – are also the four countries fueling great-power competition.
Continuing geopolitical friction among these key countries will make significant international climate coordination difficult, as will the more fragmented global order that results from this ongoing structural shift.
I therefore expect climate actions in 2021 to remain focused on domestic policies in countries around the world, as global progress on CO2 reduction remains slow and uneven.
Geopolitical risks to watch in 2021 — the usual suspects plus more “shadow wars”
President-elect Biden will enter the White House facing the most challenging geopolitical backdrop in decades, even as US domestic politics remains deeply divided and dysfunctional.
Risks abound, but here are the ones I’m watching most closely in 2021:
Taiwan: This remains the biggest geopolitical risk as Taiwan’s future becomes an even larger focus in Beijing and Washington amid great-power competition; expect continuing diplomatic pressure on Taipei from China, more diplomatic and military support from DC, and an elevated and sustained risk of military escalation.
The South and East China Seas: This is another key risk, as China continues its military expansion amid territorial disputes and the US works in closer military coordination with regional allies, and in particular, with Japan.
North Korea: Geopolitical tensions on the Korean Peninsula are likely to return in 2021, as Kim Jong Un attempts to shift global attention to stalled nuclear talks when the Biden administration takes office; intercontinental ballistic missile launches and new nuclear weapons testing could be dramatic ways to accomplish this goal.
US-Russia relations: Bilateral relations are likely to worsen under a Biden administration, with an increased US focus on shoring up NATO capabilities, particularly in Eastern Europe; President-elect Biden has also called for US government investigations into Russia’s “assault on US democracy” related to the 2016 elections; expect elevated tensions and higher sanctions risk.
“Shadow war” conflicts intensify: As great-power competition deepens, we should expect a more prominent role for national security strategies that fall just short of actual military conflict. These include offensive and defensive cyber operations, bolstered intelligence capabilities, additional covert measures to influence domestic opinion, and the growing use of economic tools, including sanctions, for geostrategic purposes.
2021 investment implications — differentiation and adaptation
From my geopolitical perspective, three trends will drive the macro and market backdrops in 2021 and beyond: COVID-19 recovery, deepening great-power competition, and climate change.
All three will likely divide the world into winners and losers, with an increasing degree of differentiation at country, policy, industry, and asset-class levels based on relative exposures to the macroeconomic impacts of the pandemic, a shifting world order, and the national security impacts of climate change.
These ongoing structural transitions are likely to be a net positive for actively managed strategies, particularly those that marry bottom-up investment expertise with the right thematic trends around the world.
Through my geopolitics lens, I believe “adaptation” is the best way to conceptualize the investment opportunities this presents in 2021 and beyond.
Trillions of dollars of capital are likely to be reallocated in the coming years to help governments, businesses, and individuals adapt to a rapidly changing structural backdrop.
This theme will be particularly acute as COVID-19, combined with great-power competition, forces a recalibration of supply-chain vulnerabilities across newly “strategic” industries in health care, biotech, and especially national security.
All of this will likely be supportive of defense spending globally, but in particular, I expect sustained demand and an increased policy focus for “dual-use” technologies now at the heart of shifting military doctrines – including semiconductors, next-generation communications, a variety of space technologies and applications, and especially artificial intelligence as applied to national security, given its potential to alter future economic and military balances of power.
The opportunity for climate adaptation may be even greater.
The best climate science indicates our planet will continue to warm for decades or longer. That fact is already creating demand for new technologies and products that will help humans adapt to this rapidly emerging environmental reality.
These include a variety of adaptations to help societies cope with higher temperatures, water scarcity issues including droughts, increased wildfires, severe storms and flooding, and other key climate-related variables, including looming social dislocations and new geopolitical frictions.
As the Biden administration moves climate to the center of the US policy agenda, and as other countries including China do the same, this emerging demand for climate adaptation is likely to grow in 2021, and will be sustained for years to come.
MACRO INSIGHTS — PART 1
A temporary crisis but a permanent fiscal response?
The global economy remains caught between opposing forces. On the negative side is renewed cyclical weakness; on the positive side are hopes that a COVID-19 vaccine may allow economic activity to return to more normal levels over the coming quarters. Uncertainty about the scale and duration of the COVID-related slowdown has persuaded households and, particularly, firms to postpone spending and run a much higher level of precautionary savings. If an effective and widely distributed vaccine is coming, markets can probably look through a jagged global cycle over the next few quarters with greater confidence that any new rise in private-sector savings will just be deferred spending.
The global cycle is likely to deteriorate over the next three to six months as restrictions are imposed in response to rising COVID case counts, keeping uncertainty hanging over the markets. That deterioration is likely to force another response from the US Federal Reserve (Fed) and the European Central Bank (ECB) at the end of 2020. But I think there is now a greater chance that markets will overlook this near-term uncertainty and focus on future growth.
Strong 2021 growth likely
After a tough start to the new year, global growth is likely to be strong while inflation remains low. In my view, global GDP could expand by 5% in 2021 as confidence in an effective vaccine pushes households and firms to run a lower level of savings. Yet, given the disruption to activity in 2020, most countries are unlikely to see GDP return to pre-COVID levels until late 2021. For some, it could be well into 2022 or even 2023.
While that excess capacity is being absorbed, I expect inflation to remain low despite strong GDP growth. In this environment, monetary policy is likely to remain very supportive. One legacy of this crisis is that central banks have explicitly changed their reaction functions and will need to see, rather than simply expect, higher inflation before taking back the stimulus. So the expansion in central bank balance sheets is likely to be huge in 2021 at around US$3 trillion, second only to 2020’s US$6 trillion.
Positive developments on the vaccine front are a game changer for the global economy. Although it is still early days and many hurdles need to be overcome, they have allowed us to have greater confidence that this crisis will prove temporary. In that environment, both equities and bond yields can rise. Equities can rotate to more cyclical leadership. Bond yields can rise, as the timing of when central banks will ultimately hike interest rates is pulled forward modestly. But, with inflation still low and central bank purchases still high, the moves are likely to be gradual rather than abrupt.
All eyes on fiscal policy
The policy response so far, though large, has been designed to fill a hole, not stimulate growth; to avoid deflation, not generate inflation. The measures were intended to soften some of the blow caused by the private sector’s forced saving. And central banks’ asset purchases have been more effective at driving up equities than convincing households or firms to spend.
After the world has adjusted to the news of a vaccine, I believe the market will turn its focus to fiscal policy: what form will it take and how persistent will it be? This will determine whether the global cycle simply returns to pre-COVID behaviours — with low growth, high debt, low productivity, low inflation and ongoing central bank-balance sheet expansions — or takes a fundamentally different path.
Countries face three broad fiscal options:
- Take back what they gave during the crisis — This would be like Japan in the 1990s or the euro area in 2011 – 12. I think this is an unlikely option, given excessive debt. Bond yields would remain close to zero, with inflation expectations stuck well below target. The outlook for equities would depend again on the willingness of central banks to keep expanding their balance sheets.
- Use fiscal policy to redistribute within society and raise the labour share of income at the expense of profits — This would mean higher taxes and even higher spending, with an effort to narrow income inequalities through lowering the cost of being out of work. The result would be an environment of stagflation, similar to the late 1960s to 1970s, with much higher bond yields, some credit problems and declines in equities.
- Use fiscal policy to promote a large investment surge — From 1945 to 1965, a fiscal expansion allowed technologies developed during the Second World War to be rolled out as economies were rebuilt. Could investment in energy and transport be today’s equivalent? That could be the path to a golden age. In that case, the market would project stronger growth, productivity and returns, as well as a higher equilibrium interest rate. As a result, bond yields and equities could rise together for an extended period.
The option chosen will vary from country to country, depending on the electorate’s political inclinations. At an aggregate global level, fiscal prudence — option 1 — seems unlikely. So, for much of 2021, it will probably feel like the policy shift is permanent. But I’m currently unsure whether fiscal redistribution or investment is more likely. The US election, like recent elections in Europe and the UK, suggests that the electorate has decided against a sharp lurch to the left, with an aggressive policy of redistribution. Equally, though, we have not yet seen many concrete plans for fiscal investment.
Looking further out
I believe positive developments on a COVID-19 vaccine can give us more confidence that this crisis will prove temporary, even though the near-term outlook is deteriorating. For me, the key unknown is whether the change in fiscal policy will prove permanent — and, if so, what form it will take. Each country faces a choice on fiscal policy between prudence, redistribution and investment.
Over a horizon of five to 10 years, this dominance of fiscal over monetary policy is a key theme for me. During the past 10 years or more — and especially in 2020 — central bank liquidity has been the one factor driving markets globally. But this fiscal era will be really exciting for investors, because it’s more about idiosyncratic country stories. Every country’s policy will be different.
For example, countries with ageing populations and high savings rates have far less incentive to really push for inflation, as Japan has shown in recent decades. But countries like the US and the UK may be more willing to persist with fiscal stimulus until inflation comes through. That implies much more risk premium being priced into markets over the next five to 10 years, with important consequences for bond and equity markets.
MACRO INSIGHTS — PART 2
Brexit: prepare for more policy stimulus
As negotiations between the UK and the EU continue, three key questions remain. One, will there be a deal? I think that is more likely than not. Two, what is the timing? All negotiations with the EU tend to go to the last moment, which is realistically around the third week in November. Three, what will that deal look like? That’s where the markets’ attention should be.
Effect on market pricing
The range of possible outcomes has narrowed dramatically this year, and I don’t think market pricing currently reflects that. Six months ago, a comprehensive trade deal between the UK and the EU was still an option. Now, the chances are close to zero. The two remaining options are a deal like Canada got or a deal on World Trade Organization (WTO) terms. Sterling, in particular, does not seem to have fully priced those risks in.
If there is no deal, UK assets will sell off. If a deal is agreed, we’re likely to see a knee-jerk rally: UK equities will outperform for a while and sterling will rise, with rates selling off.
But I think the rally will soon stall, whatever sort of deal we reach. A Canada-like deal would mean very low tariffs on goods, which would be positive. But I’ve been surprised how little attention has been paid to the services sector, which is very important to the UK’s trade with the EU. UK citizens would not be able to travel to the EU to transact services, as the UK’s services sector qualifications will not be accepted by the EU.
Such barriers are far more significant trade frictions than tariffs on goods. With a Canada-like deal, I would estimate that the average cost of doing business would be around 9% higher than currently. That’s not much better than the roughly 13% for a WTO deal. Being overweight sterling and UK equities ahead of a deal has been one of the most consensus trades, and more money is waiting to come in if a deal is done. But, once the market grasps the scale of the barriers, the rally is likely to fade.
The outlook for fiscal and monetary policy
Whatever the outcome of the Brexit negotiations, I think there will be more monetary and fiscal stimulus than the market is expecting. On the fiscal side, as the economy slows, we are likely to see more extended support measures. I think that could be followed in February or March by a meaningful fiscal response of around 1.5% – 2.0% of GDP.
On the monetary side, the Bank of England’s growth forecast assumed a comprehensive trade agreement. If that doesn’t happen, the Bank will have to cut its forecast dramatically even before considering the impact of the latest wave of COVID and the new lockdown. I expect around another £100 billion of asset purchases by the end of the year, with more to follow in the first quarter. Even so, I think the supply of gilts in 2021 will easily outstrip the Bank of England’s demand, particularly relative to 2020. In that environment, I would expect gilts to continue selling off.
There has been a lot of talk about the possible introduction of negative rates. I think the Bank of England is worried that it is getting less bang for its buck with asset purchases, particularly at the front end of the curve. As a result, it is likely to keep floating the idea of negative rates to keep yields low and the curve constrained.
The consensus view appears to be that negative rates are more likely in the event of a no deal. I disagree. If there’s no deal, sterling will probably fall significantly, putting UK banks under stress. So I think the Bank of England would avoid negative rates, which are a tool to prevent currency appreciation. If there’s a deal but the economy continues to weaken, I think that’s when negative rates are more likely, even though the hurdles are still high.
I think 2021 is going to be a challenging year for growth and inflation in the UK. The UK economy has been one of the hardest hit by COVID and is experiencing one of the slowest recoveries. It also has a number of issues that will persist beyond Brexit, such as the uncertainty over capital expenditure. So, while growth is likely to be positive in 2021, I think the UK will probably underperform other parts of the world. GDP may not return to pre-pandemic levels until around the second quarter of 2022, which is a long way off, and there may be a worsening trade-off between inflation and growth. In this environment, any big positive moves for sterling will probably fade.
about the authors
Geopolitical Strategist, Boston
As a member of the firm’s Global Macro Strategy Group, Thomas conducts research on the macro and market implications of geopolitical risk. In his role, he also focuses on internal and external communication efforts, with a particular emphasis on connecting our macro insights to actionable investment ideas in client portfolios.
Macro Strategist, London
As the investment team leader of the firm’s Global Macro Strategy effort and a member of the Global Bond Team, John leads our global macroeconomic strategy efforts and contributes to the management of global portfolios for the firm’s clients around the world. He focuses on macro forecasting & analysis and monetary policy for the UK and Europe, as well as the global cycle, translating key macro data into investable ideas and themes and working closely with investors around the firm.
ACTIONABLE IDEAS 2021
This is an excerpt from our 2021 Investment Outlook, in which specialists from across our investment platform share insights on the economic and market forces that we expect to influence portfolios in the year to come.