The economic data flow since our last report has been better than we expected into early 2021. Despite a longer and stronger wave of COVID infections in late 2020 (mainly in the West, as East Asia and Australasia continued their impressive outperformance in containing the pandemic), fourth-quarter GDP numbers came in almost universally above our forecast. Our interpretation is that in many countries, governments and citizens learned to better manage the effects of the virus. As a result, we raised our estimate for global GDP growth in 2020 by 50 basis points.

Moreover, the uneven pattern of output since the beginning of the pandemic persisted. Namely, relatively strong household spending drove growth in the U.S. and relatively strong industrial production and exports drove growth in East Asia (including a tech trade boom). Europe is in between, as it benefits from an adapting but still constrained consumer and the restart in world trade. Emerging markets mostly resembled East Asia, with continuing resilience of manufacturing and commodities sectors underpinned by strong foreign demand.

Chart 1

The news on the vaccine front has been encouraging on balance, and the beginning of the end of the pandemic is now in sight. New vaccines continue to hit the market and rollouts are accelerating, although at highly uneven rates. At this point there is a race between vaccination and mutations. The U.K. and the U.S. are outperforming on the vaccine front (see chart 1). Asia generally lags on vaccine rollouts, but this should be seen in light of much lower caseloads and fewer (but more targeted) restrictions on mobility.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Policy settings remain generally accommodative as economic activity in many countries remains below pre-COVID levels, labor markets remain soft, and the degree of scarring from the pandemic remains unclear. The big news over the first quarter was the passage of the massive $1.9 trillion American Rescue Plan. Fiscal policies elsewhere remain stimulatory although debt levels are coming back into focus as the recovery builds. Central banks are signaling that they will maintain their current stances until the recovery is well entrenched and unemployment falls to pre-pandemic rates. Central banks' shift to waiting for actual outcomes to materialize rather than acting on expected outcomes, in the context of revising their inflation targeting strategies, implies more tolerance for running the economy a bit hot. This will result in some inflation overshooting and create two-way risk.

Markets are moving and are now pricing in a U.S.-led recovery. U.S. 10-year yields are up by 70 basis points to 80 basis points since the election last November, although they remain around 150 basis points below notional long-term rates. Some of the recent rise in U.S. yields has spilled over to yields in other developed country domestic currency markets, while some pressure on those emerging markets (EM) reliant on foreign investors in domestic currency markets has appeared. In response, three EM central banks raised rates in late March, albeit partly for idiosyncratic reasons. We see orderly reflation driven by higher growth expectations as a healthy development; a growing risk is volatility around this path caused by an uneven recovery.

U.S. Forecast Supports Higher 2021 Global Growth

The main reasons for our revision of the 2021 global growth forecast are North America (with the U.S. forecast rising 2.3% on the back of the big fiscal stimulus plan), and China and India both rising by 1.0%. On the downside we have lowered our forecasts for the eurozone (by 0.7%) and the U.K. (by 1.7%). Changes to the forecasts for 2022 and 2023 are broadly unchanged in aggregate (see table). Combining these forecasts with the upward revision to 2020 growth, global GDP will be more than 1% higher over 2020-2023 compared with our previous forecast.

A significant amount of uncertainty surrounds our baseline forecast: relative paths of vaccination, mobility constraints, response of firms and households, re-alignment of sectors, ultimate loss of output, and change in growth potential.

U.S.

The outlook has improved significantly in recent months. An accelerating pace of vaccinations, a faster reopening schedule, and the $1.9 trillion stimulus in addition to the $900 billion package approved in December, all point to a seismic shift in the outlook relative to where it stood in December 2020. Our forecasts of real GDP growth of 6.5% would be the highest reading since 1984. Despite the improved outlook, we see jobs as a lingering weak point in the recovery, with unemployment, adjusted for labor force composition, reaching its pre-crisis rate only by the second half of 2023. We think the expected spike in inflation in second-quarter 2021 will prove transitory. Still-high unemployment and low inflation will keep the Fed on hold until late 2023. Our risk for recession over the next 12 months is now 10% to 15%, down sharply from the 20% to 25% range in January.

Eurozone and U.K.

A slow start to vaccinations combined with a new ripple of lockdowns have led us to lower our growth forecast for 2021 by 70 basis points to 4.2%. A strong finish to 2020 partially offsets these developments. The hit to growth this year is larger for economies more dependent on tourism (Spain) than for those more dependent on foreign trade (Germany). Nonetheless, the eurozone economy is positioned for a strong restart, although this will take longer than we previously expected. Upstream price pressures are unlikely to feed through to consumer prices and we expect the ECB to keep rates on hold for the next two years, while asset purchases may need to be raised to counter any spillover in rates from the U.S. The pace of fiscal spending will be less supportive of growth than in the U.S. this year, while implementation of the EU recovery plan is likely to be felt mostly from 2022. U.K. growth has been down sharply this year due to the severity of lockdowns, with activity pushed into 2022.

Asia Pacific.

The region will benefit from a stronger global recovery. While the vaccine rollout may lag other regions, we expect enough progress to lift consumer spending, the weak spot in the recovery so far, later in 2021. We forecast China to grow by 8% in 2021 (up from 7%) on stronger trade and real estate activity. We raised India's growth to 11% from 10% (in fiscal 2021), due to faster-than-expected re-opening and fiscal stimulus. We kept Japan at 2.7% in 2021 but see upside risks from exports. We revised emerging market growth lower on a delayed, but not derailed, recovery. Inflation in most Asia-Pacific economies should remain subdued. Central bank rates will mostly stay on hold, although the Reserve Bank of Australia will likely be the first advanced country central bank to exit extraordinary measures. The risks to our baseline are balanced. The pandemic and higher real bond yields are on the downside with improving external demand, consumption booms, and productivity gains on the upside.

Emerging Markets.

We see generally better macroeconomic outcomes this year as the pattern of strong industrial output and exports, and weak services persists. Vaccine deployment remains uneven. We forecast GDP growth for our EM-14 group (excluding China and India) of 4.4% in 2021, 20 basis points above our previous forecast. The largest economies in this group each face idiosyncratic challenges: Turkey (balance of payments); Brazil (fiscal and political); and Russia (sanctions). We see a more supportive fiscal stance in some cases compared to our previous assumptions. Risks to our baseline include a third wave of infections and slower progress in vaccinations as well as an abrupt tightening in financial conditions, linked to rising U.S. yields on the back of the fast-paced U.S. recovery.

Reflation Is Welcome, But Disorder Carries Risks

Our central macroeconomic narrative is driven by an improving pandemic situation and the resulting normalization of economic activity, supported by very accommodative monetary and fiscal policies. These provide hope for an orderly reflation.

We see reflation--higher rates and yields--as positive on balance. Reflation is desirable as long as it reflects higher growth and earnings expectations (implying stable real interest rates) rather than only higher inflation (implying higher real rates). Indeed, we think inflation fears are overblown. While we may see higher transitory inflation on the back of the U.S. stimulus plan, as the output gaps close and the labor market tightens, the Federal Reserve knows how to lower inflation back to its target (see "Return of the Fed's Punchbowl," published Feb. 26, 2021; link in Related Research).

Chart 2

Orderly reflation and the normalization of rates and yields carry several benefits (see "Orderly Global Reflation Will Support The Recovery," published March 22, 2021). First, they will reduce the search for yield, which has led investors further out the credit curve to achieve their desired returns. Second, they will curb excesses in asset prices, which move inversely to interest rates as well as the use of inflated assets as collateral for credit. Finally, further down the road, moving policy rates away from zero will give policymakers room to maneuver and cut rates in the event of future downturns.

Disorderly reflation is a risk to watch and can have several dimensions. The Fed could underestimate the wage and price response to the stimulus, forcing it to raise rates quickly; this would not only slow the U.S. recovery, but would almost certainly generate a round of market volatility that would reverberate in other economies. Even if the U.S. stimulus plays out domestically as intended, differences across sector recoveries could put firms with slowly growing earnings under stress as funding rates rise. And the differential between the U.S. rebound and the rest of the world could open up interest rate and growth caps that could pose challenges to emerging markets, such as capital outflows, or for advanced markets to the extent that higher U.S. rates leak into their domestic markets.

While an orderly reflation from the COVID-19 economic shock is not guaranteed, it is important not to confuse orderly reflation, which is beneficial, with the risks of disorderly reflation.

A Better Spot Than Expected Overall, With Much Uncertainty

Our forecasts suggest that we are currently in a better spot than expected even a few months ago. While the pandemic is not over, and progress remains uneven, new vaccines continue to be rolled out and vaccination rates are accelerating. This allows for an opening of the sectors hardest hit from the social distancing restrictions and should propel some degree of convergence.

Policies remain accommodative and there is little evidence of premature fiscal austerity, which was a risk given what transpired after the global financial crisis. Indeed, with fiscal space larger in many countries than previously thought, governments are erring on the side of doing more than expected. This is happening quickly in the U.S., and more gradually in Europe and in some key emerging markets. Monetary policy remains extraordinarily accommodative, with major central banks vowing to respond only to contemporaneous wage and price pressures, rather than expected or model suggested pressures. This will drive inflation higher and unemployment lower and introduce two-way risk into these key variables.

Finally, the degree of convergence back to normality depends on what shape the post-COVID economy takes and how quickly we get there. While we agree that the recovery from the pandemic is more accurately called a restart, we are not going back to an end-2019 world. Priorities and preferences have changed and that means the composition of production and consumption will change. And at this juncture there is much uncertainty: we don't know exactly what this post-COVID world looks like.

But some elements of a post-COVID economy are becoming clear. More flexible work arrangements, a faster pace of digitalization, and more emphasis and health security and social contracts. Less box-store shopping, less commuting, less personal contact, at least for a while. And it will take time for the socially interactive sectors to reinvent themselves, at least partially. Flexible markets and flexible policies can smooth the transition, protect the most vulnerable, and build a path to a post-COVID world.

Related Research

S&P Global Ratings' research

• Orderly Global Reflation Will Support The Recovery From COVID-19, March 22, 2021
• Economic Outlook Europe Q2 2021: The Path To A Strong Restart, March 25, 2021
• Economic Outlook Asia-Pacific Q2 2021: Three-Speed Recovery Will Benefit from Faster Global Growth, March 25, 2021
• Economic Outlook Emerging Markets Q2 2021: Tailwinds From Stronger Global Growth, But Several Challenges On The Radar, March 30, 2021
• Global Credit Conditions Q2 2021: The Risks Of An Uneven Recovery, March 31, 2021

Other research

• Return of the Fed's Punchbowl, Feb. 26, 2021: https://www.linkedin.com/pulse/return-feds-punchbowl-infrastructure-stronger-us-se-asia-gruenwald/.

The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.