The Delta Variant Is The Growth Delta

COVID-19 continues to play a central role in global economic activity. In economies where the delta variant has surged in recent months--the U.S. and Southeast Asia in particular--mobility and confidence have declined and growth has slowed. This has happened despite rising vaccination rates in some cases. In contrast, in economies where the spread of the virus has been contained or where tolerance for infections has risen, such as Europe and non-Asia emerging markets, the pace of activity has remained strong. We continue to see a large gap in vaccinations between richer and poorer countries. See "Global Economic Outlook Q3 2021: Picking Up Steam, Fueled By Vaccinations," published June 30, 2021.

Chart 1

Another pandemic-related development has been economies' adaptation to the virus. Specifically, economic agents are learning to live with mobility restrictions put in place by governments to combat the spread of COVID-19. Charts 2a and 2b show this trend, with the change in mobility plotted on the horizontal axis against the consumption gap on the vertical axis, both measured against their pre-COVID-19 levels.

In comparing the second quarter of 2020 with the first quarter of 2021, the curve has clearly shifted upward, suggesting that for a given level of mobility restrictions, the impact on consumption has lessened as the pandemic has persisted. This result holds in aggregate as well as for the majority of Organization for Economic Cooperation and Development (OECD) and non-OECD countries in our sample.

Chart 2a

Chart 2b

High-Frequency Macro Data

High-frequency data over the past quarter shows the changing pattern of global growth. Manufacturing activity remains strong as consumers continue to demand durable goods, which is keeping purchasing managers' indices (PMIs) elevated. This higher demand reflects shifts in housing and work arrangements in response to the pandemic and has been fueled in part by consumers unlocking excess savings. The pattern is generally stronger in advanced economies than in emerging ones, including China (see chart 3a).

The big divergence over the past quarter has come in the services or nonmanufacturing sector. Here the earlier outperformance seen in the U.S. PMI has faded owing to pandemic trends. Likewise, China's nonmanufacturing PMI continues to slide, reflecting a sluggish services recovery, including lackluster household spending. In contrast, European service sector performance has powered ahead as vaccination rates and consumer confidence have risen together. Beyond the major economies, there is no discernible difference in developed and emerging market PMIs.

Chart 3a

Chart 3b

Global trade remains buoyant as well, although it appears to be leveling off. Spending on durables--which has spurred activity along supply chains--along with the uptick in commodity demand has propelled the increased trade.

Meanwhile, momentum has broken with bottlenecks in some sectors, most notably chips, which have held back production in sectors including electronics and autos. Given the structural nature of the demand shock (work-from-home arrangements, the need for additional [greener] cars, and a preference for higher inventories) and the sluggish supply response, S&P Global Ratings analysts see pressure in the chips sector lasting another year. Despite supply constraints, elevated prices are helping producers' bottom lines.

Central Banks Are Acting As Inflation Picks Up

As the recovery continues at a brisk pace, inflation has come to the fore. In the U.S., a wide variety of inflation measures--the Producer Price Index, Consumer Price Index, and Personal Consumption Expenditure Price Index (which the Federal Reserve targets)--all rose well above the central bank's target of 2% at midyear, and they look set to remain higher than initially projected rates for the next few quarters. Sequential data suggests most measures have peaked but remain high. Inflation has remained more contained in the eurozone, although energy prices have recently risen.

In response, central banks in advanced economies have begun to remove certain extraordinary accommodations, with small and medium-size economies in the lead. Central banks in Norway and Korea have recently raised rates, while central banks in Australia, New Zealand, Sweden, and the U.K. have begun to reduce asset purchases. Following its September meeting, the Fed has moved up the timing both for tapering (to begin in late 2021 and end in mid-2022) and rate liftoff (to take place in late 2022), while the European Central Bank (ECB) remains firmly on hold for now with a commitment to communicate on the future of quantitative easing by mid-December.

Price pressures have been more prominent in emerging markets, especially outside of Asia-Pacific. Less anchored medium-term inflation expectations have compounded these pressures. The combination of these factors has forced some central banks to raise rates aggressively as their economies recover from the pandemic. Brazil and Russia, for example, have raised rates by 425 and 250 basis points this year, respectively, with Chile and Mexico raising rates as well. (Turkey cut rates in late September, despite high inflation, after raising rates aggressively earlier in the pandemic.)

Moreover, emerging market central banks will be watching capital flows as the major central banks begin to taper their asset purchases. In the event of a pickup in outflows, central banks may be forced to raise rates to protect the balance of payments and support exchange rates.

Our Updated Forecasts

We see global growth this year as broadly unchanged from our previous forecast, despite sizable swings in its composition. Our updated forecast is for a 5.8% global expansion this year (see table). The main downward projection in the current forecast is for the U.S., which we now see growing by 5.7%, a full percentage point lower than previously. We have also lowered our forecast for China by 0.3 percentage point to 8.0%.

On the upside, we expect eurozone growth at 5.1%, revised up from 4.4%, and we also raised our forecasts for several major emerging markets. Details of these forecasts appear below as well as in the cited related research.

Our outer-year forecasts show smaller composition changes but were also broadly unchanged. We see global growth slowing to 4.4% in 2022 and decelerating further to 3.2% in 2024, close to its pre-COVID-19 trend. These numbers reflect modest upward revisions to growth in the U.S. and Japan. The risks to our forecast remain on the downside on balance.

U.S.

Growth in the world's largest economy has cooled somewhat but remains resilient. Supply disruptions remain the leading cause for the moderation in growth, with the delta variant now adding drag. Our forecasts for real GDP growth for 2021 and 2022 are 5.7% and 4.1%, respectively, from 6.7% and 3.7% in our June report--still a 37-year high. The U.S. recession risk over the next 12 months remains at a six-year low of 10%-15%.

With the labor market still 5.3 million jobs short of the pre-pandemic peak, a full recovery could take a while, despite the headline unemployment rate at 5.2%. Inflation also remains higher than the Fed originally expected, but we still consider the rise to be transitory because price increases have not been broad based. Medium-term inflation expectations remain well anchored.

We expect the Fed to begin tapering asset purchases in December (after announcing it in November) with policy rate liftoff in December 2022, followed by two rate hikes each in 2023 and 2024. Government debates on infrastructure, funding, and the debt ceiling are near-term risks.

See "Economic Outlook Q4 2021: The Rocket Is Leveling Off," published Sept. 23, 2021.

Europe

The rebound of the eurozone economy since restrictions were lifted in March and April has been surprisingly strong in terms of both GDP and employment. In our view, the vaccination rollout has given consumers more confidence to go back to the shops and hospitality. As a result, we have raised our growth forecast for 2021 to 5.1%, from 4.4% previously.

The strength and speed of the recovery have caused material shortages and rising commodity prices, leading us to revise our inflation forecast upward for this year to 2.2% from 1.8%. However, we continue to see inflation decelerating below the ECB's 2% target next year, on the back of subdued wage developments and falling growth momentum. The regional inflation outlook remains somewhat uncertain, however, as energy prices remain on the rise.

While the ECB is likely to stop net asset purchases under the pandemic emergency response program by the end of March 2022, we expect it will step up net purchases under its traditional quantitative easing program and possibly redefine the program itself. As a result, we don't expect the ECB to stop total net asset purchases before the end of 2023, and thus we expect no rate hikes until the end of 2024. A resurgence of the pandemic and rising energy prices are downside risks to our outlook.

See "Economic Outlook Europe Q4 2021: A Faster-Than-Expected Liftoff," published Sept. 23, 2021.

Asia-Pacific

Activity has been slowing in Asia-Pacific as the delta variant has imparted a negative impulse to growth. Shutdowns are crimping mobility and spending, reducing production and confidence. That said, the tolerance for outbreaks is growing as vaccination rates rise.

We have lowered our 2021 GDP growth forecasts for the region this quarter by 0.4 percentage point to 6.7%, with almost all countries forecast to see a weaker expansion than previously. This reflects slower consumer activity, as well as a spate of regulatory actions in China, the repercussions of lower growth in China across the region, and the effects of the delta variant outbreak in Southeast Asia.

Inflation remains contained in most of the region, although central banks in Korea, Australia, and New Zealand have raised rates or begun to taper asset purchases. The risks to our baseline forecast are on the downside, reflecting uncertainties around the path of the pandemic and the extent to which China will rein in its private enterprises.

See "Economic Outlook Asia-Pacific Q4 2021: Growth Slows On COVID-19 And Rising China Uncertainty," published Sept. 27, 2021.

Emerging markets

Emerging markets in Europe, the Middle East, and Africa (EMEA) and Latin America saw surprise growth in the second quarter as economic agents adapted to lockdowns. This was particularly true in the service sectors, while exports, especially commodities-related, expanded rapidly as well.

Emerging Asia tended to lag its emerging market peers owing to the outbreak of the delta variant. We increased our 2021 GDP projections for the major Latin American economies by 0.5 percentage point to 6.5% this year, and for emerging market EMEA economies by 0.7 percentage point to 4.8%, mainly reflecting stronger-than-expected second-quarter activity. Our GDP growth forecasts for 2022 and beyond are broadly unchanged.

Inflation could remain higher for longer in emerging markets should supply-chain disruptions linger, given less anchored expectations. Further vaccination is also required to lessen the risk of stop-and-go reopenings, with emerging markets generally lagging the advanced economies.

See "Economic Outlook Emerging Markets Q4 2021: Vaccination Progress And Policy Decisions Remain Key To Growth," published Sept. 27, 2021.

Risks Remain On The Downside

Developments regarding the pandemic remain the top downside risk to our baseline global economic outlook. While vaccination rates are up in many countries and the economic impact of mobility restrictions has lessened, we are not out of the woods yet. As delta has shown, especially in Southeast Asia, variants of COVID-19 can still have a measurable and even severe impact on economic activity. Higher vaccination rates, particularly in lower-income countries, will mitigate this risk.

As we begin to exit the pandemic, the market response to monetary policy normalization is also a growing risk. While an orderly reflation remains our macro-credit base case, the chance of a disorderly transition to a more normal rate structure still exists. This risk could be amplified by the higher levels of debt amassed in fighting the pandemic. Emerging markets, which have a higher risk of sharp moves in capital flows (needed to finance budget and current account deficits), less anchored inflation expectations, and lower fiscal space, would feel the effects more acutely.

The final risk to our outlook is China's medium-term trajectory. As we've argued before (see "China Credit Spotlight: The Great Game And An Inescapable Slowdown," published Aug. 29, 2019), China has benefited massively from integrating with the rest of the world in previous decades, including through the transfer of technology and best practices, which have boosted productivity and per capita growth. A model of excessive self-reliance and increased restraints on privately owned enterprises runs the risk of materially slowing trend growth, however. And the effects will not only be domestic. Given China's position as the leading contributor to global growth, the impact of any slowdown would touch a wide swath of other economies as well.