William De Vijlder

Group Chief Economist BNP Paribas

US inflation: increasing discomfort

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Loading 2021

A global macro economic analysis after 18 months of pandemic

A conjunction of developments has led in the first semester of the 2021 to a global improvement in business and consumer sentiment in advanced economies. Vaccination campaigns gathered speed while the number of new infections declined. Monetary policy support also played a part as well as fiscal policy. International trade and capital flows created international spillover effects which led to a sizeable improvement in the assessment of export orders.

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US Treasuries: buyer beware

The significant decline of Treasury yields from their peak at the end of March is puzzling given the growth forecasts and the recent inflation data. This suggests that investors side with the Fed in thinking that inflation will decline. It also reflects the weakening of data in recent weeks, which implies that markets focus more on the change in the growth rate than on its level. The sensitivity of bond yields to economic data moves in cycles. One should expect that, as seen in the past, a less accommodative US monetary policy would increase this sensitivity because these data will shape expectations of more tightening or not. Before reaching that stage, we should already expect an increased sensitivity in the course of 2022, because it is quite likely that inflation will remain above the FOMC’s target.

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Looking beyond peak growth

The first half of the year has seen a broad-based improvement in business and consumer sentiment in advanced economies but elevated levels of business surveys reduce the likelihood of further significant increases. The third quarter is expected to see the peak in quarter-over-quarter GDP growth this year. Nevertheless, over the remainder of the forecast horizon –which runs until the end of next year- quarterly growth is expected to stay above potential. This favourable outlook for the real economy brings challenges for financial markets. Surprising to the upside in terms of earnings will become more difficult. Moreover, there is the question of the inflation outlook. For the time being, both the Federal Reserve and markets are relaxed about it but we should expect that over the coming months, the market sensitivity to growth and inflation data will be higher than normal in view of what they would imply for the Fed’s policy stance.

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Economic Growth

Eurozone: unemployment, consumer confidence and household spending

The labour market should play a crucial role in the recovery through its impact on household income and spending. There are reasons to be hopeful considering that recent business surveys show a further increase in hiring intentions whereas unemployment expectations of households have dropped below their pre-pandemic level. Household intentions to make major purchases over the next 12 months have already increased and this trend should continue on the back of an improved financial situation and reduced income uncertainty.

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ITW Bloomberg 28 June 2021

Delta variant and economic growth

William de Vijlder, BNP Paribas Chief Economis is interviewed by Anna Edwards and Mark Cudmore on “Bloomberg Markets: European Open” and discusses the delta variant issue and the outlook for economic growth.

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The (unwarranted) stagflation narrative of 2021

Strong US and Eurozone GDP growth in the second and third quarters should be followed by a gradual slowdown. Due to the ‘acquis de croissance’ going into the fourth quarter, the perceived slowdown versus the third quarter could be much bigger than what shows up in the current forecasts. In the US, the current elevated inflation will take time to decline. In conjunction with slowing growth, this could boost the stagflation narrative. Such a depiction of the economic environment seems unwarranted however, considering that inflation should decline further in the first half of next year and that the US economy should continue to grow above potential.  

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EcoTVWeek du 25/06

Is there a risk of stagflation? 

The 1970s have gone down in history as an era of stagflation, defined as a period of slow or even negative output growth and inflation that is high by historical standards. Two supply shocks in the oil market are considered as a key cause but other factors also played a role. In the course of this year, the lifting of restrictions related to Covid-19 has caused an imbalance between supply and demand, leading to a significant pickup in inflation. There is concern that growth, after being particularly strong, will slow, whereas inflation might stay elevated for longer. This has given rise to comments that stagflation, albeit in a lighter version, could make a comeback. However, this risk seems limited.

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Federal Reserve: enhanced credibility

More FOMC members than before are projecting a rate hike in 2022 and Jerome Powell made it clear during his press conference that tapering would happen when circumstances would justify this. Yet, 10 year Treasury yields, after an initial increase, ended up trading below the pre-FOMC meeting level. Break-even inflation also declined. Bond investors seem to share the view of the Fed that the current elevated inflation will be a transient phenomenon. This also explains the decline in the price of gold. The negative reaction of equity markets reflects an increase in the required risk premium and shows a certain unease about the impact of a less accommodative monetary policy on the growth outlook.

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Inflation higher for longer? The interplay between productivity, profit margins and pricing power

A complex interplay between unit labour costs, profit margins and pricing power will determine whether the current increase in inflation will be longer-lasting. Traditionally, in the early phase of a recovery, unit labour costs decline on the back of increased productivity. This should cushion the impact of higher input prices on profit margins. Subsequently, unit labour costs should increase but this does not imply that margins should decline. Given the strength of the growth acceleration, the fact that alternatives for meeting robust demand often do not exist and that going for market share makes no sense when faced with supply constraints, the conditions seem to be met for a rather significant transmission of higher input prices in producer output prices.

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Zone euro

Eurozone: peak growth momentum => peak in bond yields?

Historically, a very close correlation has been observed between cyclical peaks in German economic sentiment –which since the start of the euro more or less coincides with the peak in Eurozone economic sentiment- and the 10 year Bund yield. The latter tends to decline, once the peak in sentiment has been passed. Although other factors also play a role in the dynamics of long-term interest rates, the historical experience is important to keep in mind when assessing the outlook for bond yields.

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The ECB: under pressure

Judging by the recent data, the acronym PEPP that was introduced last year when the ECB launched its Pandemic Emergency Purchase Programme, could also be seen as a reference to the pandemic’s exceptional price pressures.  The upcoming governing council meeting and the new staff projections are eagerly awaited. Whether PEPP will be prolonged beyond March 2022 ultimately depends on the inflation data. It seems likely that the ECB will postpone its decision until after the summer in order to have a better view of the inflation outlook.

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Central bank inflation forecasts: ‘Trust us, we know better’

Strong belief in the quality of central bank economic forecasts enhances monetary transmission and hence the effectiveness of monetary policy. In the current environment of rising inflationary pressures, the belief of market participants that central banks have better forecasting skills should limit the rise in inflation expectations. Research casts doubt on whether such a belief is warranted. Although Fed staff projections tend to have lower forecast errors than private sector forecasts, the difference has narrowed since the 1990s. In the Eurozone, forecast errors for inflation of the Eurosystem/ECB staff projections were equal to those of the Survey of Professional Forecasters.

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Uncomfortable inflation

Usually during recovery phases following a recession, it takes quite some time before inflationary pressures begin to appear. Yet the 2020 recession was atypical, and the recovery is proving to be just as unusual. Growth should receive abnormally strong support in the quarters ahead. What if price acceleration was not temporary, contrary to the reassuring comments of the Fed’s monetary policy committee members?

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Illustration Blog 21.20

Supply bottlenecks and the inflation outlook

In countries where restrictions on mobility are lifted, demand picks up suddenly, causing an imbalance with supply, which takes more time to react, in particular when value chains are long and complex. In recent months, companies have been reporting longer delivery lags and rising input costs, but the historical experience in the US and the euro area shows that the impact on inflation should be temporary and limited. Nevertheless, in bond markets, break-even inflation has increased significantly in recent months, reflecting investor worries about the risk of upside surprises to inflation. Should supply-side pressures ease in coming months, one would expect break-even inflation to decline as well.

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Illustration EcoTV mai 2021

US: back to the seventies?

In the debate on economic policy in the United States, some observers warn we may be back to the seventies. It was a period of severe shocks – move to floating exchange rates, two major oil crises –, high and accelerating inflation and an increased role for the State.

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Serendipity lost? Working from home and innovation

Working from home is expected to have a positive impact on the level of productivity but will it also influence its growth rate? The answer largely depends on what happens to innovation. Interaction between people is key for idea generation and the exchange of information. Formal interaction can be easily organized using a variety of software applications but informal interaction is a bigger challenge. To make sure that serendipity within and amongst teams –given its importance for a culture of innovation- is maintained, a combination of working from home and onsite seems to be recommended.

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US: which insights from the ‘great inflation’ of the 1970s?

The ‘great inflation’ of the 1970s had many causes. The policy objective of full employment had already led to high inflation by the end of the 1960s. Two oil shocks and the depreciation of the dollar caused additional increases. The key factor was monetary policy, which was not adapted to the circumstances. It reflected the view that the Fed did not have a mandate to tolerate the sizeable increase in unemployment that might have ensued from the aggressive tightening needed to bring inflation under control. In addition, inflation was considered to be a cost-push phenomenon that could be addressed with wage and price controls. Today’s situation is very different. The Federal Reserve is an independent central bank and inflation expectations are well-anchored. However, letting the economy run hot is reminiscent of the 1960s.  Should inflation be above target for too long, the Federal Reserve will need to have the courage to tighten policy sufficiently despite the potential cost to the economy.

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Illustration ITW Brexit BNPP Fortis

Brexit and its economic aftermath

How does doing trade with the United Kingdom look like in a post-Brexit world? A few months after the Trade and Cooperation Agreement between the EU and the UK came into force on 1 January 2021, what is its impact on companies trade and the economy as a whole? What can Belgian corporates with interests in the UK expect in the future? My colleague Simon Gates and myself are sharing our insights in this video.

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Illustration édito 21.17

Working from home and labour productivity

One of the lasting consequences of the Covid-19 pandemic will be the way we work with more time spent on working from home compared to the pre-pandemic situation. Clearly, the possibility to do so depends to a large extent on the industry, the nature of the job but also the country. These developments would have profound implications on where people decide to live, the role of cities, the need for office space, the use of means of transport, the needs in terms of IT infrastructure (high-speed internet), etc. A priori, one would expect a positive impact on productivity, in particular due to increased worker satisfaction and efficiency. Based on recent surveys, that is also what companies seem to expect. However, empirical research shows that the impact on productivity largely depends on factors such as the IT infrastructure, employee preferences and the way it is introduced and accompanied by company management.

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Green finance

Green investments, public debt and financial markets

Limiting global warming will require huge investments, which will partly have to come from the public sector. This could lead to a crowding-out effect. Higher public borrowing requirements could push up interest rates and weigh on private investments. In the near-term such a risk seems remote. On the contrary, there could be a crowding-in effect with a reduction in climate-related risk and positive second-round effects from green public investments stimulating private investments. To reduce the risk that financial markets would exclusively focus on the impact on public indebtedness, governments should communicate clearly on the nature of their investments, insisting that they should have a return which is a multiple of the borrowing cost.

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About William De Vijlder

Group Chief
BNP Paribas
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