Expectations for GDP growth recovery in European economies are deferred, in view of a prolongation of lockdown measures to contain Covid-19
The strong upward momentum continued in the past week as US equity markets factor in the prospect of additional fiscal stimulus. The S&P500 increased by 1.2% on a weekly basis, while equity implied volatility subsided further with the Vix index declining to 20% -- a one-year low.
Euro area equities increased by 0.8% on a weekly basis (+0.9% on Monday) with Italian assets overperforming as M. Draghi was sworn in as Italy's Prime Minister. Commodities have benefitted the most during this reflationary shift, with Brent crude oil prices up by 22% year-to-date to $63/brl.
The political debate in the US for a new massive fiscal stimulus package continues regarding (i) the size ($1.9 tn or 9% of 2019 GDP); (ii) the breakdown of measures (extended unemployment insurance, direct aid to households via $1400 checks, support to States and health care spending); and (iii) how to spread the relief out more over time to mitigate potential fiscal cliffs down the road.
Without doubt, the proposed measures will burden further the stock of US debt. According to the US Congressional Budget Office, the federal budget deficit, under current law, is already set to reach 10.3% of GDP in fiscal year 2021 (i.e. from October 2020 to September 2021), following a deficit of 14.9% of GDP in fiscal year 2020. As a result, the ratio of public debt to GDP at the federal government level, is currently projected to hover at c. 100%. However, interest payments as percent of GDP are exceptionally low (1.6% in 2020) mitigating, inter alia, these concerns.
Another concern is whether the new stimulus could spark inflationary pressures. Recall that a vast amount of accumulated personal savings is expected to feed consumer demand after the economy fully reopens. In the event, taking the difference from March 2020 to December 2020, between personal savings and the respective average monthly figure during 2019, we estimate the accumulated extra savings due to the pandemic at circa $1.6 tn or 7% of 2019 GDP. On the other hand, looking forward, households could engage in more precautionary behaviour and save more compared with past norms, due to the Covid-19 shock.
On the other side of the Atlantic, the European Commission revised down, compared with three months ago, its estimate for euro area real GDP growth in 2021, by 0.4 pps to 3.8%. That development is due to the resurgence of Covid-19 and new, more contagious, variants of the coronavirus, aggravating the epidemiological data and leading to tighter and more prolonged restrictions. On the other hand, the respective estimate for 2022 was revised up by 0.8 pps, also to 3.8%, with the commencement of vaccination rollouts, brightening the prospects.
The main assumption in the aforementioned scenario is that containment measures retain largely their current strictness throughout Q1:2021 (when real GDP is projected by the EC to contract by 0.9% qoq), ease only marginally towards the end of Q2:2021 and more markedly in H2:2021, in tandem with the progress in vaccination programs. In all, European Commission's baseline scenario suggests that euro area GDP will return to pre-pandemic levels in mid-2022.