Moreover, vaccine distribution is under way, thereby setting the stage for a considerable acceleration in growth later in the year. As in the United States, full implementation of the vaccine will likely entail a reduction in household saving and an increase in spending on consumer-facing services.
Even in the best of circumstances, many countries will remain laden with debts that could stymie growth and create financial vulnerabilities. All these factors are, in some degree, dependent on whether or not the world succeeds in suppressing the virus. The fourth quarter outbreak of the virus on the European continent quickly abated due to the imposition of economic restrictions as well as reduced consumer mobility.
For European governments, an improvement in growth will work wonders for government finances, which have been severely disrupted during the pandemic. The European Central Bank will likely continue to provide support to the market for government debt, especially as long as inflation remains muted. The big uncertainty concerns how quickly this will take place and at what cost. Still, when recovery comes, we can expect that middle- to upper-income households will stop saving such a large share of their income and, instead, spend more on consumer-facing services, such as restaurants and travel. This shift in behavior will go a long way toward boosting the rate of economic growth. Yet even a robust recovery later this year will not likely erase the troubles faced by many former employees of consumer-facing industries who are expected to remain unemployed.
But , as Alpha Tactics described in mid-December, some inflation signals are at 19-month highs. Diane Swonk of Grant Thornton explains the financial shortfalls in states and localities as a result of COVID’s blow to the economy; this sector accounts for one in ten jobs. She also details longer term changes in the labor market, including many women forced to quit working to take care of children since education moved online. A new aid package from the federal government could alleviate much of the pain being felt by workers and small business owners. Labor market expert Diane Swonk of Grant Thornton emphasizes that looking after both the health of the economy and that of individuals is compatible, not competitive.
She points to the data that shows consumers avoided going out for fear of infection, well before any official lockdowns took place. Recent news on prospective vaccines is encouraging but avoiding lasting economic or health effects will require vigilance. Treasury bond yields have begun rising but should remain low by historical comparisons. We anticipate the Fed will keep its policy rate near zero through 2022 and may expand its asset purchase program.
In addition, many governments in the European Union extended support for the labor market well into 2021, thereby averting further economic distress. The result is likely to be a strong upturn in growth in the first quarter of 2021 after a likely decline in activity in the last quarter of 2020.
Rising growth and inflation expectations may push longer-term bond yields somewhat higher, but rates are unlikely to return near historical averages any time soon. Treasury bonds provide important portfolio diversification, but low and rising yields indicate there are better opportunities elsewhere to enhance yield and performance. Most global central banks are maintaining low borrowing rates to stimulate economic activity. Asset purchases from the Federal Reserve, European Central Bank and Bank of Japan also continue to support financial markets and economic activity.
Disruption of the job market will be a longer-term problem, one whose solution will be debated in Congress. Foreign interest in Chinese assets, which includes substantial US participation, has been driven not only by Chinese deregulation, but by other factors as well. In addition, the growing interest of US-based financial services companies in the Chinese market is, in part, driven by expectations that the Chinese middle class will continue to grow at a fast pace. A rising middle class in a country of high savers is attractive for the sale of wealth management and other services. Inflation hawks have been sounding the alarm for years as the Federal Reserve conducts round after round of support for the economy, ballooning the balance sheet to record levels. The FOMC Minutes are due Wednesday — a key indicator of where the members expect the economy and prices to move. And nonfarm payrolls are due later this week — an event that could upend economic growth projections.