How soon can the world economy recover post vaccine? How will this affect you? Image Credit: Gulf News Archives

Dubai: While analysts largely foresee a wide-scale rollout of a vaccine in the first six months of 2021, economies and businesses are currently expected to recover to pre-pandemic levels by the end of next year. Since this is the view that’s largely taken on by most analysts, let’s then also look at the impact an economic rebound will have on your finances and investments.

When it comes to global economic recovery, analysts at Switzerland-based investment bank UBS – in a report published on Tuesday looking into the year ahead – sees an antidote being rolled out globally in the first half of next year, which will enable global output and corporate earnings to return to pre-pandemic highs by the end of the year.

Economists caution, however, that even if a successful immunization system does come along, it won’t act as an instant economic remedy. Meaning, in terms of actually getting back to pre-COVID growth levels, it could take more than a year.

Convinced of light at the end of the tunnel

Ever since the recent updates of vaccines from US-based pharmaceutical companies Pfizer and Moderna came to light, financial markets worldwide were convinced that there was finally light at the end of the long COVID-19 tunnel. Globally, shares in companies most affected by social distancing – airlines, cinemas, brewers, hotels – all soared in a strong vaccine rally that is still continuing.

Data has previously indicated how the economic impact of COVID-19 not only comes from lockdowns and restrictions but from voluntary social distancing as well, and analysts reiterate that if vaccines reduce the fear of being infected it might have a bigger positive impact on the recovery.

In its half-yearly World Economic Outlook in October, the International Monetary Fund said it expected global growth of 5.2 per cent next year on the assumption that social distancing would continue into 2021, but would then fade over time as vaccine coverage expanded.

Is an even speedier recovery possible?

The IMF also added then that a speedier recovery was possible. “Progress with vaccines and treatments, as well as changes in the workplace and by consumers to reduce transmission, may allow activity to return more rapidly to pre-pandemic levels than currently projected, without triggering repeated waves of infection.”

However, there are some analysts who are of the opinion that while the recent vaccine developments are significant and diminished risks of a prolonged global economic recovery, the implementation and adoption of the vaccine can still extend the economic progress.

“The recent encouraging COVID-19 vaccine developments bode well for a significant easing of restrictions on activity in 2021, while diminishing downside risks relating to delayed medical advances to control COVID-19,” wrote analysts at London-based Oxford Economics, in their latest blog entry.

“Some countries may be able to implement fairly speedy vaccination programs for the most vulnerable, paving the way for much less stringent curbs on social activities slightly ahead of the mid-2021 timing we had assumed in our existing forecasts,” the analysts added, while cautioning however that progress globally still looks set to be slower.

Interest rate moves set by central banks key for recovery

While the analysts at UBS noted that they anticipated few inflationary threats in 2021, they further added that they expected interest rates to remain low for the foreseeable future. But what does this mean for the global economy and key debt, credit, commodities and foreign trade markets. The article looks at this in detail next.

With US being the world’s largest economy, every economic move that the US makes has immediate effects on global markets. At a basic level, raising interest rates go hand-in-hand with appreciating currencies, and vice-versa. And in many parts of the world, the US dollar is used as a benchmark of current and future economic growth. In developed countries, a strong dollar is seen in a positive light.

With the pandemic, central banks have been quick to act in slashing interest rates – rates that were already sitting at historic lows before the crisis. Since only the beginning of March, the world’s central banks have cut interest rates on 37 separate occasions.

Central banks continue to pull economies out of a crisis

The world economy has for decades been reliant on central banks to pull itself out of a crisis, and now since the start of the current health crisis, an unprecedented level of cash injection (stimulus) was required to keep growth intact, and the central banks did just that.

The most meaningful rate cuts happened on March 3 and March 15 after emergency meetings in the US, which governments worldwide were quick to follow. With rates sitting at zero, it’s not impossible for the US central bank (the Federal Reserve) and other central banks to begin toying more seriously with the idea of negative rates, analysts opine, while adding that such a move would be bold, but also seen as highly experimental and risky with unforeseen consequences.

As the progress around a vaccine advance, economists see central banks looking to keep interest rates low for now and inject stimulus only if necessary, up until their respective economies and businesses reach pre-pandemic functionality.

Vital to also see how rates impact US dollar, other currency rates

Historically, rising interest rates have gone hand-in-hand with an appreciating US dollar, and vice-versa, lowering interest rates mean a depreciating dollar. This, in turn, affects economic facets domestically and around the world—particularly the credit market, commodities, stocks, and investment opportunities.

Cuts in interest rates in any country tend to make its currency lose value against others. That is because lower interest rates mean there is less money to be made by investing in that country's assets, since they're yielding less interest. Primarily that means government bonds.

Could the post-pandemic timeline be a historical repeat that followed the 2008 crisis?
In the aftermath of the 2008 Financial Crisis, the US Federal Reserve implemented years of easing of interest rates to stimulate economic recovery, slashing rates to a near-zero, where they remained for the next six years.

The idea was to spur investments, along with consumer spending, and drag the US economy out of recession. In the years that followed, the economy did recover, which economies worldwide tracked. Multiple analysts are forecasting a similar trajectory this time around after vaccines become available.

How economic recovery affects long-term investment plans

From an investment perspective, a shift to higher economic growth should be good for stocks, driving up corporate profits and allowing companies to strengthen their balance sheets further, while boosting merger activity among firms and delivering more money to investors as dividends.

However, volatility could meanwhile intensify, and bonds could become more competitive with stocks if yields rose. But volatility to the extent of stocks market crashing, is very much an unlikely event if economic growth picks up.

Here is what analysts at UBS note with regard to their view on long-term investing, in the current backdrop of economies gradually recovering post-pandemic.

“Future returns are likely to be lower than in recent years across all major financial assets. But the outlook for equities and other real assets is more favourable than for government bonds and cash,” the analysts wrote in their latest outlook report for 2021 and beyond.

Those who have money riding on the movement of stock markets – which have historically been the first indication of any sentiment shift seen among investors – will continue to look to data from vaccine and treatment trials for signs of hope just as much as they pore over stimulus plans coming out of key economies worldwide.

“Diversify out of low-yielding cash and bonds and hunt for yield in emerging market US dollar-denominated sovereign bonds, Asian high yield bonds, and select crossover bonds that are close to the dividing line between investment-grade and high-yield rated issuers,” the UBS analysts added.

“Position for a weaker US dollar. Investors should diversify across G10 currencies or into select emerging market currencies and gold.”

What are G10 currencies?
The G10 currencies include the Australian dollar (AUD), Canadian dollar (CAD), Euro (EUR), Japanese yen (JPY), New Zealand dollar (NZD), Norwegian krone (NOK), British Pound sterling (GBP), Swedish krona (SEK), Swiss franc (CHF) and the US dollar (USD). In some banking circles, reference is made to the G11 currencies, which are the G10 currencies plus the Danish krone (DKK).

How lower interest rates impact dollar-denominated debt markets

Dollar denominated debt outside the United States currently amounts to $12.2 trillion (Dh44.8 trillion), as at the end of 2019, with emerging markets amassing $3.9 trillion (Dh14.3 trillion). Countries such as Turkey, Brazil, and South Africa, which perpetually run trade deficits, finance their current account deficits by building up dollar-denominated debt.

In situations where US interest rates decrease – like the current given pandemic backdrop – while the dollar depreciates, the exchange rate between developing nations and the US tends to narrow. As a result, dollar-denominated debt owed by developing nations decreases.

How lower interest rates impact credit markets

Lower interest rates lead to an increase in the money supply and depreciation of the dollar. At the same time, lending and credit markets expand. Global credit markets follow the movements of US Treasury Bonds (or government bonds).

And, as interest rates decrease, the cost of credit does, too. From bank loans to mortgages, it becomes less expensive to borrow. Hence, a decrease in the cost of capital can improve consumption, manufacturing, and production.

Analysts add that the most profound consequences of interest rate cuts in the US are likely to be on Asian economies. During the past seven years, China has borrowed from foreign banks to stimulate growth. This borrowing was fuelled by lower interest rates. With further prospective loosening of credit conditions, foreign lending to heavily indebted countries is expected to rise, economists reveal.

How lower interest rates impact commodities markets

Oil, gold, cotton and other global commodities are priced in US dollars, and a weakening currency following a rate cut would decrease the price of commodities for non-dollar holders, boosting trade.

Economies that rely primarily on commodity production and an abundance of natural resources will be better off. As the products of their principle industrial increase in value, their available credit streams will rise.

How lower interest rates impact foreign trade globally

Again, briefly revisiting an economic principle when it comes to interest rates impact on related markets - lower interest rates tend to be unattractive for foreign investment and decrease the currency's relative value and demand.

The exchange rate has an effect on the trade surplus or deficit, which in turn affects the exchange rate, and so on. In general, however, a weaker domestic currency stimulates exports and makes imports more expensive.

How an economic rebound can impact personal finances

Government intervention historically has worked against savers; stimulus spending and increased inflation can both work against the power of cash savings. When a government provides an economic stimulus package to its citizens, it typically finances those expenses through additional sovereign debt.

Printing more money is another way that governments may pay for legislation that includes a government stimulus. When this happens, there's a higher risk of inflation. Inflation can be said to be a recognised dampener for savings.

With inflation, each dollar-linked monetary unit in your savings account has less real purchasing power. (Purchasing power is the value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. When there are high rates of inflation, one unit of currency, is not capable of purchasing the same amount of goods as in a prior period.)

As with most economic crises, the savings rate shot up in the aftermath of the Great Recession. This trend, matter experts reveal, was partly the result of those people who could afford to save making the decision to stash their cash in anticipation of tougher times ahead.

On both a personal and an economic-level, matter experts further reveal that maintaining a savings rate is one of the best cures for economic woes. While this may mean living within means for a certain period of time, it also means that we'll be less susceptible to economic downturns in the long term, after the effects of a pandemic pass.