null We Get Questions
Macro & Market

We Get Questions

Macro & Market Article
October 2020
We Get Questions

Authors & Contributors

Vincent Reinhart

Vincent Reinhart

Rowena Geraghty

Rowena Geraghty

Aninda Mitra

Aninda Mitra

Nick Tocchio

Nick Tocchio

At Mellon, our views on the economy and sovereign risk are central inputs to our assessment of the valuation of financial assets informing portfolio choice. We summarize this, very briefly, in our quarterly Fixed Income Investment Landscape. We post many supporting documents for clients here on—including Global Macro Views, Economic and Market Observations and Fed Thoughts, among others, which are discussed quarterly in a presentation for interested clients.

In the interest of transparency, we gathered below some of the questions that cropped up during the latest round of updates. We always welcome more, which you can send directly or via your relationship manager.

The Global Outlook 

Q: Can you highlight the risks around market consensus of global GDP growth expectations for 2021 if a second COVID wave hits developed markets at a time when a viable vaccine is still uncertain?

A: We believe Federal Reserve (Fed) Chair Powell is right and we have put the pandemic at the center of our economic outlook. There will be no return to normal economic functioning until the general population is comfortable about health risks. That is, ultimately, we will presumably have herd immunity, perhaps sped along by a vaccine next year. And, even after that, there will be structural shifts in light of the lessons learnt about social contact. The reopening of schools and cooling weather in the Northern Hemisphere are associated with an inflection up in the case and death curve (but less so the latter). Do not rule out that it gets worse. However, the world is better at social distancing, contact tracing, and treatment. Moreover, we are all tired of lockdowns, so the economic dislocations will likely ease even if the caseload does not.

Q: How does the emergence of a second wave of COVID-19 infections in Europe especially influence the economic outlook there? 

A: Based on the earlier experience of the US in 2020—and that of the Spanish flu in 1918-1920—we had already incorporated a second wave of COVID-19 infections into our economic outlook. It is our expectation that most European countries will avoid a repeat of the extremely strict lockdowns seen in April/May 2020, given that advances have been made in medical management of COVID-19 and national health systems have greater resources available. Instead, we expect European countries to focus on localized lockdowns and increased social distancing measures to manage this second episode of the pandemic, although these measures are unlikely to be quite as effective at reducing mobility as previously. However, if there is a medical need to revert to the previously strict lockdown measures, we would accordingly downgrade the economic rebound in 2021. 

Q: Will China’s macro exceptionalism persist?

A: We expect that China’s large growth and policy-rate differential versus advanced economies and most major emerging markets will last at least through the first half of 2021. China has been able to stamp out Covid-19 infections more effectively than most other countries, has the pole position in manufacturing medical equipment and high-tech products, and benefits from the global shift toward online activity and digitalization. Production and fixed investment have also picked up sizably and reflect large changes in the fiscal and credit-impulse (though, not as generous as during the Global Financial Crisis). However, the normalization of household consumption will take more time—and require greater policy support as well as reforms to improve income-distribution and social-safety nets. In coming quarters, base-year effects from the growth collapse in early 2020 and the lingering impact of China’s policy and credit stimulus will ensure that GDP expands around 10 percent in the first half of 2021 before normalizing to a 5-percent handle in the second half. The longer-term (beyond 2021) outlook hinges, among other things, on China’s geopolitical relationship with key trading partners and the speed of rotation of global and regional supply chains closer to sources of final demand or toward alternative, low-cost locales. 

Q: How does the recent leadership change in Japan impact our outlook? 

A: The resignation of Prime Minister Abe last month introduced a new element of political uncertainty to Japan, including whether his successor would continue along the policy lines of “Abenomics”. The dust has since settled, and Yoshihide Suga, Abe’s former chief cabinet secretary, was selected to serve out the remainder of Abe’s term as Prime Minister. PM Suga has demonstrated a strong commitment to continuing the policies of Abenomics with an added emphasis on deregulation. It looks increasingly likely that snap elections will be called in the first half of 2021 in order to cement Suga’s administration beyond the remainder of Abe’s term, which expires in October 2021.

We expect a continuation of Abenomics style policy and a close working relationship between the fiscal authorities and the Bank of Japan (BoJ). The fiscal spending taps will remain turned on over the medium-term as broad fiscal policy priorities are unchanged. Our base case is for the BoJ to maintain a holding pattern on the policy rate, yield curve control, and quantitative easing for the foreseeable future.  Even so, core inflation will still most likely be negative in 2021, which will create some headaches at the central bank. For now, this will not prompt serious discussion of a rate cut in Japan, especially if the yen remains stable.

Q: How will the rest of Asia fare amidst the asymmetric V-shape recovery?

A: There is a clear separation emerging between North- and South-Asia. In the North (in which we include Singapore), recoveries from Covid-19 have been faster, and the export bases of most of these countries are geared toward either capitalizing on the global demand shift toward medical and pharmaceutical supplies and high-tech equipment as well as the demand for capital and intermediate products in China. To be sure, many wealthier Asia economies are still reeling from the downturn in tourism and business travel, which casts a shadow over entire sectors of their respective economies ranging from aviation to hospitality and retail sales. As such, until a vaccine is widely distributed and effectively raises herd immunity, we continue to expect policies in most advanced countries of Asia to remain accommodative or even deliver a bit more easing. South Asia has suffered far more Covid-19 infections due to less advanced testing and tracing capabilities as well as poorer compliance with social distancing. Rolling lockdowns have decreased in intensity; and activity indicators are on the mend. Many of these countries have large, domestically oriented, service sectors, which will take more time to normalize. The slower recovery implies continued pressure on fiscal and credit metrics although the rollout of an effective vaccine could allay ongoing concern and may result in a snapback in risk perceptions. 

Q: What is your view on white-collar job losses and permanent job losses in the US? Second, do you think high debt levels will prevent inflation to shoot higher and keep growth capped? What do you think will cause inflation to move higher?

A: The pandemic shock is regressive, hitting lower-income households much harder. White-collar workers can perform most of their functions remotely. Blue-collar workers require a physical presence and a lot of those in the service industry are supporting white-collar work in business districts that are now empty. (Check out, which uses big data to look at income-distribution issues.) Through the end of August, employment among those earning less than $27,000 per year is still off 18 percent from pre-pandemic levels. Employment among those earning more than $60,000 annually is back to about unchanged. 

There will be permanent job losses among white-collar workers associated with sectoral shifts in light of change attitudes about social risks. Air travel, especially business travel and the attendant expenditure on hotels and conference venues, could be setback by half a decade. The location of work associated with a lessened need for physical presence is shifting, along with personnel needs. Additionally, brick-and-mortar delivery of products and services got a further push downhill.

High debt levels are more likely to be associated with higher inflation over time. An unexpected pick-up in inflation erodes the real value of that debt, making excessive burdens more sustainable. General complacency about deficits also makes politicians more willing to spend pro-cyclically, making a central bank’s job of controlling inflation harder.

Policy Considerations

Q: Where will Brexit stand at the end of 2020? 

A: We currently assign a 60 percent probability of the UK and European Union (EU) agreeing and legislating a trade deal by the end of this year. This trade deal will likely be relatively limited or “skinny”, with a focus on goods on zero tariffs and quotas. A year-end deal would still leave non-tariff trade barriers in place for goods and services (including financial services), although they may subject to negotiations in later iterations. Whilst current commentary focus on the potential potholes of fishing and state aid, the landing zone for these issues is visible. This, of course, leaves a 40 percent probability of no trade deal agreement—and the possibility of UK-EU trade devolving to a World Trade Organization (WTO) basis. This would entail considerable disruption to the supply of goods (particularly food), as well as significant price rises on imported goods due to tariffs. Given the political ramifications of such disruptions, we expect the UK government to seek to avoid such an outcome at all costs. 

Q: Do you include the potential for negative rates in any scenario for the United States? What probability is assigned to it?

A: As opposed to their colleague central bankers, most Federal Reserve officials have always been very negative about negative policy rates. Reserves exist in a closed system, in that the amount outstanding in the banking system is entirely determined by the Fed’s balance sheet. As a result, there is no way for the banking system as a whole to evade a negative deposit rate, which really should be thought of as a tax. If banking is competitive, intermediaries pass that tax along either to depositors (in the form of lower deposit rates) or borrowers (in the form of higher lending rates). If there is market power in banking, it comes out of profits in part, which makes banks less attractive to investors and lowers leverage in the system. In all three cases, loan volume goes down as the size of bank balance sheets shrink. This is decidedly unhelpful to the macroeconomic situation.

Central banks never say never, and they would not reject a potential tool outright. All the language coming from the Fed (including a relatively direct dismissal in the minutes) suggests that a negative policy rate is at the bottom of the tool box. They would use it at a time of severe macro distress, not because they think it was helpful, but because its use signals the Fed’s resolve to do whatever it takes. Over the next five years, we put the probability of this scenario at 5 percent.

Q: What is the core problem with the Fed’s new longer-run strategy?

A: The goals that the Congress assign the Fed are very general, “…maximum employment, stable prices, and moderate long-term interest rates.” Over the years, officials of the Federal Open Market Committee (FOMC) have interpreted this as consistent with price stability in the long run. The idea is that only when prices are stable will employment be at its maximum and long-term nominal interest rates moderate.

Q: How should price stability be defined? 

A: Fed officials settled on a quantitative goal of 2 percent but have struggled to lock that notion into prevailing public perception. The core problem is that the FOMC cannot credibly commit in any one year to a multiyear plan because its membership changes every year. As a result, a sitting FOMC cannot bind the plans of future ones. The solution early last decade was to have each newly-minted FOMC ratify an unchanged longer-run promise at the start of the year, on the hope that the force of repetition would create binding precedent. 

The new statement (the tablets the chair brought down from the virtual mountaintop of Jackson Hole) fit the current situation of resource slack and low inflation, not the longer-term outlook. Moreover, they promised to revisit the wording of the statement regularly. A promise that is fit for the moment and may be rewritten regularly is not credible about a longer-run commitment.

Asset Valuation

Q: From asset allocation perspective looking out twelve to eighteen months, where do you see the most upside—the US, Emerging Markets, Europe, or Asia?

A: Most financial assets seem expensive relative to fundamentals given the massive policy accommodation from major central banks. However, emerging market economies have especially suffered from the pandemic shock and have fewer resources to blunt the adverse effects. Hit particularly hard are those dependent on the export of commodities or remittances from citizens working abroad. They correspondingly have the most room to improve as the global economy rebounds. Extended depreciation of the exchange value of the dollar will assumedly add to the return from local-currency debt.

Technical Matter

Q: Can you elaborate between the nowcasts of quarterly GDP growth from the Federal Reserve Banks of Atlanta and New York? 

A: In the battle of Federal Reserve Bank’s on GDP nowcasting, the Atlanta and NY Fed follow different rules. Atlanta is trying to replicate the bean counting of incoming data done by the national-income analysts of the Bureau of Economic Analysis. Take the incoming information that comes in at different frequencies and map that into components of spending. The goal is to fit the top line of what the US Bureau of Economic Analysis (BEA) will ultimately publish. NY is asking what underlying but unobservable index of economic activity best explains all the data. In some sense, staff in NY are trying to create reliable observations of the “true” state of the economy. For Atlanta, the twists and turns of GDP are reflected in a one-third decline (at annual rate) in the second quarter to be followed by an opposite-signed increase of about the same rate. (Remember high-school arithmetic: equal but opposite percentage changes leave the level lower.) For NY, unobserved activity in the second quarter declined by a smaller percentage to rebound the same amount in the third quarter. If you want to track the BEA published report, follow Atlanta, if you want to curb your enthusiasm about swings in the underlying economy, follow NY. We follow both.

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