Capital Ideas^TM

Quarterly macro and market insights from Capital Group’s fixed income team

The global economy maintained its positive overall trajectory, though economic indicators grew more mixed. Returns across fixed income were mostly flat to negative for the quarter as an array of developments unsettled the stock market. Inflationary pressures in the US and Europe, global supply chain disruptions and rising COVID-19 infection rates in Asia all weighed on sentiment.

For the first time in the recovery, the global PMI looked likely to decline quarter-on-quarter. Economic activity in emerging markets weakened amid patchy vaccine availability and limited fiscal stimulus. For emerging markets overall, the PMI dipped below 50 — a level indicating contraction in manufacturing activity. Looking forward, we expect growth potential for emerging markets will lag what was seen in the years preceding the COVID19 pandemic.

The US Federal Reserve is poised to start tapering its asset purchases before year-end. Against a backdrop of persistent inflation, September’s Federal Open Market Committee meeting cemented our take on how the Federal Reserve (Fed) will likely proceed.

US jobs growth of around 150,000 or higher should be sufficient for tapering to commence in November. As Fed Chair Powell stated, the threshold of “substantial further progress” on employment was, in his view, “all but met.” He added: “I don’t personally need to see a very strong employment report, but I like to see a decent employment report.”

Fed taper policy doves appeared to capitulate. According to Powell, the plan to taper asset purchases from November 2021 through mid-2022 was broadly supported among committee members. Earlier in the year, calls for a later start and slower pace had been quite prominent.

US inflation may be less transitory than was previously expected. The supply shock, which had originally been expected to subside quickly as COVID19 cases declined, is now a critical factor in the inflation outlook for the US (as well as the UK and eurozone). As global productivity has eased, inflation has climbed to multiyear highs in a number of economies. With no nearterm remedy to supply chain disruption apparent, elevated inflation will likely persist into 2022.

Slower global growth is meeting with elevated inflation pressures. The current situation with inflation seems largely the result of supply-side factors. Quantitative easing, wage pressure and the low amount of slack in the economy are, in our view, less significant contributors. A combination of high inflation and economic slack (as evidenced by the US economy’s negative output gap) is relatively unusual. It’s not difficult to see how current conditions could lead to an economic environment where the unemployment rate in the US climbs to 5% or higher, while inflation remains above 3%.

China’s economy will likely continue to lose momentum through 2022. The early recovery following the start of the COVID-19 pandemic is fading, as underscored by recent real GDP and manufacturing and services PMI data. Unless Chinese authorities relax some of their more restrictive financial policies, we expect both credit growth and the credit impulse to weaken further.

A missed coupon payment by Evergrande Group added to broader concerns around China. Evergrande (one of the nation’s largest property developers) and its other highly leveraged competitors are under pressure due to Chinese policymakers’ focus on reducing risks in the real estate sector. The government has sought to rein in the sector’s speculative issuers by introducing upper limits on debt ratios.

 

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