Much of Australia is back in a pandemic lockdown. Tokyo opened the Olympics on Friday under a state of emergency. The Netherlands has had to reimpose restrictions on cafés, bars and nightlife. New travel warnings have hit Spain’s hopes of a revival in tourism, and Italians will soon have to show a health pass if they want to see a film or swim, after prime minister Mario Draghi followed France’s lead and took steps to prod people into seeking vaccination.
The unwelcome return of restrictions has planted a new fear in the minds of investors: that the rapid spread of the coronavirus Delta variant could bring the global recovery to a juddering halt.
Just 10 days ago, markets were fixated on the risks of overheating economies stoking a surge in inflation — piling pressure on policymakers to consider an early withdrawal of pandemic-era stimulus measures. This week began with a sharp sell-off in global equities as fears grew over the spread of the Delta variant. By midweek, stock prices had bounced back — but US Treasury yields remained at rock bottom levels, suggesting creeping doubts about the strength of the global recovery.
So swift has been the turnround that anyone following the twists in global markets over the past fortnight could well be suffering from whiplash.
“As the Delta variant has picked up, the narrative seems to have changed from ‘look at how inflation is rising!’ to ‘look at how growth is slowing!’,” wrote Ajay Rajadhyaksha, analyst at Barclays. Meanwhile Alan Ruskin, chief international strategist at Deutsche Bank, says the episode has shown the resilience of investor demand for risky assets — but has also put paid to a previous “gangbuster view of the world opening up in synchronised fashion”.
The spike in coronavirus cases linked to the more infectious strain of the virus has brought public health concerns back to the fore just as it seemed the end of the pandemic might be in sight for some countries — with governments around the world forced to pause or reverse reopening plans.
“It’s a risk that we are putting more and more emphasis on,” says Gregory Daco, chief economist at the consultancy Oxford Economics, who warns of the potential for it to lead to an uneven global recovery, “with some economies going potentially back down into an environment of tighter social restrictions and social distancing measures”.
That anxiety was reflected by Christine Lagarde, president of the European Central Bank, on Thursday. She said the Delta variant was “a growing source of uncertainty” as she set out a new pledge by the central bank to be more tolerant of inflation before raising interest rates.
The UK has shown that even with a high vaccination rate, and a political decision to tolerate higher rates of infection, there is no easy way to avoid economic disruption once the Delta variant has taken hold. Although social distancing rules ended on Monday, hundreds of thousands of workers have had to stay home to self-isolate after coming into contact with someone who tested positive — leaving the government scrambling to avert public service shutdowns and empty shelves in supermarkets.
Yet despite the growing risk posed by the Delta variant to the global outlook, policymakers and economists believe its impact is more likely to dampen rather than derail the recovery in major economies, where vaccination programmes have weakened the link between infection and hospitalisation.
Jennifer McKeown, at the consultancy Capital Economics, says there are some signs of people becoming more cautious about going out in the UK, with the upward trend in trips for shopping, leisure and work — encouraged by the progressive lifting of restrictions — stalling as people try to avoid being forced to self-isolate just as the holiday season starts.
Survey evidence also points to shortages of staff and materials starting to weigh on business activity. But even in the UK, consumers are still spending and businesses are still scrambling to hire.
In the eurozone, business activity grew at its fastest rate for 21 years in July as many countries continued to lift Covid-19 restrictions. The spread of new cases has barely dented consumer confidence.
Lagarde said business surveys and hard data confirmed the ECB’s June forecasts, which assumed some lockdown measures would continue to the end of the year. “The eurozone recovery is on track,” she wrote on Twitter, “but we are not yet out of the crisis.”
US inflation focus
In the US, fears of overheating and excessive inflation remain dominant. During two days of congressional hearings last week, Jay Powell, the chair of the Federal Reserve, fielded far more questions from lawmakers on the central bank’s management and assessment of rising prices than on the economic impact of the Delta variant.
The US has a significant buffer to absorb a new coronavirus-related hit without plunging back into recession. Fed officials in June projected that gross domestic product would grow at a pace of 7 per cent this year, with the unemployment rate dropping to 4.5 per cent — after nearing 15 per cent at its pandemic peak — by the end of 2021.
Jason Furman, a professor at Harvard and former economic adviser to Barack Obama, says that while it is right to be nervous about the Delta variant, it should not change the macroeconomic trajectory. This, he argues, is because those who are at most risk of infection in the US — the people who have chosen not to be vaccinated — are also the least likely to change their behaviour. And that the states most in need of new social distancing rules “are the low vaccination states that are least likely to implement those rules”.
Yet, even in the buoyant US economy, where wage pressures are increasingly evident, Delta’s rise could make Fed rate-setters more cautious about an early exit from stimulus.
If the coronavirus situation were to deteriorate further in the coming months, it would pose a big dilemma for US policymakers, because they have been pivoting towards removing fiscal and monetary stimulus, rather than preserving it or even boosting it.
Some Fed officials have warned that the central bank needs to be attuned to the danger of an economic setback caused by new coronavirus outbreaks. “I think one of the biggest risks to our global growth going forward is that we prematurely declare victory on Covid,” Mary Daly, the president of the Federal Reserve Bank of San Francisco, told the Financial Times in early July.
But Daco says: “The appetite for strong fiscal buffers or strong monetary policy buffers is much less than it was a year ago. So that begs the question of how resilient the US economy is without the fiscal support, without the monetary support.”
The rise of the Delta variant is also complicating the policy debate in other countries. In the UK, the recent strength of inflation has taken the Bank of England by surprise, leading some rate-setters to hint that they might vote for an early end to quantitative easing. But others on the monetary policy committee have taken a more nuanced view — including Jonathan Haskel, an external member, who said this week that a return to tight policy was “not right” for now, because the economy faced two headwinds — “the highly transmissible Delta variant and a tightening of the fiscal stance”.
In the eurozone, despite the rapidly improving outlook, there is no immediate pressure to tighten policy. The ECB’s projections show inflation still falling short of its new, more ambitious target of 2 per cent by the end of 2023.
In contrast with the gyrations elsewhere, Asia has seen relatively little volatility in the economic outlook, even as the Delta variant has taken hold in some countries. A relatively slow start to vaccination, combined with smaller fiscal stimulus packages, meant there was no comparable moment when a booming recovery and overheating seemed possible.
Despite talk of a new global inflationary era the Bank of Japan, for instance, will not reach its 2 per cent inflation objective in the foreseeable future, so interest rates will not rise. Indeed, the outlook for a Japanese recovery has dimmed as Covid-19 cases rise, giving rise to talk of a fresh round of fiscal stimulus.
Economists are also far less sanguine about the outlook for other advanced economies where vaccination campaigns have lagged — Australia and New Zealand among them — and policymakers are now racing to catch up before the Delta variant overtakes them.
China’s zero tolerance policy for coronavirus infections allowed its economic recovery to begin well before the US, but it now creates big hurdles to a full reopening — because the authorities impose travel restrictions or shut down neighbourhoods whenever new cases break out. “That takes a toll on consumption since it’s practically difficult for China to keep virus cases at zero,” says Larry Hu, an economist at Macquarie Group.
Although second-quarter growth outpaced most economists’ expectations, Beijing warned of an “unbalanced” recovery and of the risks stemming from Covid-19 variants. Analysts point to other drags on growth, including the global chip shortage; rising domestic credit risks; a drop in state-backed infrastructure investment and the US administration’s ban on investment in Chinese technology.
By far the most vulnerable to the spread of Delta, however, are emerging economies in Asia and Africa, where death rates are rising to their highest level since the start of the pandemic and policymakers have limited ability either to impose new lockdowns or to support growth.
Gita Gopinath, the IMF’s chief economist, last week highlighted the “dangerous divergence” between advanced economies and many emerging and developing countries, which had limited access to vaccines, rapidly dwindling fiscal support and were already facing a rapid rise in interest rates forced by talk of US Federal Reserve tapering.
Catherine Mann, who has just stepped down as Citi’s chief economist to join the BoE’s MPC, argues that the divergent fortunes of advanced economies — and the even starker divisions among emerging ones — make the global recovery far more fragile than headline forecasts might suggest.
“Many people are looking at global growth rates right now of 6 per cent and thinking, ‘This is fabulous’,” she said in evidence to a UK parliamentary committee this week. But that growth rate was already set to slow dramatically next year, she added — and was now increasingly reliant on a sustained US recovery, and vulnerable to upsets in emerging markets.
“In understanding the challenges and the risks associated with Covid, we had all thought that we were closer to the light at the end of the tunnel,” she told MPs. “But these additional mutations have really generated some [global] concern . . . It does imply lower growth for emerging markets. [And they] are a very big chunk of the global economy.”
Additional reporting by James Politi in Washington, Robin Harding in Tokyo, Sun Yu in Beijing and Edward White in Seoul
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