Mean reversion: Three-minute macro

As we head into the reopening and slowly return to a more normal life, the concept of mean reversion should play a big role in the coming months. In the United States, we expect COVID-19-affected inflation categories to mean-revert while we're getting strong signals from Europe that the economic recovery is under way. In Asia, however, a resurgence of COVID-19 led to a decline in manufacturing activity.

U.S. Inflation breakdown

This month, we published our 10 inflation commandments detailing how we see inflation evolving in three phases: 

  • First, with a sizable pop in inflation beginning in April 2021 data, peaking in May 2021, and then remaining fairly elevated into September 
  • Second, a deceleration into 2022 toward 2% as the reopening produces a normalization of demand supply 
  • Finally, from 2023 onward, some moderately higher inflationary pressures stemming from larger structural fiscal spending and a deglobalization trend

Throughout all three phases, it’ll be important to keep a top-down perspective (i.e., monitor the output gap, wage and, global inflationary pressures, the U.S. dollar, etc.). However, we think that a bottom-up approach, or a line item by line item analysis, will be more instructive as to what’s fueling demand and inflation.

Throughout COVID-19, three categories weighed sizably on inflation: lodging (i.e., hotels), airline fares, and apparel. Intuitively, these were items that households weren’t purchasing. On the flip side, used cars and household furnishing/renovation activity were extremely popular and contributed upsides to inflation. As we head into the reopening, it’s natural to expect that these categories should reverse. Problematically, however, this won’t occur smoothly. As we witnessed in April’s inflation data, the factors that weighed on inflation have flipped to being positive contributors, but we have yet to see the unwinding of the COVID-19-inflation categories. That should happen, but likely with a lag. In addition, while month-over-month data will show large jumps in the prior drags, those prices will likely be returning to pre-COVID-19 levels. That’s in contrast with used cars and household furnishings, which are, indeed, higher than pre-COVID-19 levels. Heading into the reopening, it’s natural to expect all of the COVID-19-affected categories will mean-revert—both the upsides and downsides. 

Contribution to headline CPI by biggest upside and downside contributors

 Stacked bar chart showing the contribution to headline CPI by biggest upside and downside contributors from September 2019to April 2021. The chart shows Used cars & trucks and Household furnishings & operations have been the largest positive contributors since August 2020 while Airline fare and Apparel have been lagging.
Source: U.S. Bureau of Labor Statistics, Macrobond, Manulife Investment Management, as of April 2021.

Each COVID-19-affected inflation category will likely mean-revert to its pre-COVID-19 level over time

Chart showing price variations inCOVID-19-affected inflation categories from September 2019 to April 2021(rebased to 100). The chart shows a rebound over the past couple months in hard-hit categories, namely Lodging, Airline fare, and Apparel.
Source: U.S. Bureau of Labor Statistics, Macrobond, Manulife Investment Management, as of April 2021. Rebased to 100, where 100 = January 2020.

Asia’s manufacturing activity is losing steam

Asia’s May manufacturing PMIs broke an almost uninterrupted series of gains, declining on an unweighted-average basis to 52.3 from 53.3 in April. Since manufacturing has been a major pillar of growth for the region, we’ll be monitoring this in case of a more sustained downtrend. 

The biggest drags on the overall PMI index were India, Thailand, Malaysia, and the Philippines on the back of the resurgence of COVID-19. Indeed, the economic outlook for much of emerging Asia has deteriorated in recent weeks in response to a sudden jump in COVID-19 infections. Most countries in the region have reintroduced restrictions to slow the spread of the virus, and the high-frequency data suggests that mobility has fallen sharply. 

There are some mitigating factors (more targeted lockdowns, more timely policy support through the lockdowns) that suggest the economic impact will be less adverse than in 2020, but deterioration in the outlook reinforces our view that rates will remain low across the region for some time yet.

We continue to monitor flagging economic momentum in China (China’s large manufacturers PMI eased further to 51.0 in May) and rising margin squeeze as additional risks here.

Manufacturing PMI heatmap

Table showing manufacturing activity around the world by country and region from January 2021 to May 2021. In general, manufacturing activity is slowing in Asia while picking up in developed markets, particularly in the U.S. and the U.K.

Source: IHS Markit, Manulife Investment Management, as of June 3, 2021.

It’s now Europe’s turn to reopen

One of the major themes of 2021 has been to play staggered reopening’s as different countries/regions emerge from COVID-19-related restrictions—and momentum is quickly building for Europe. Earnings have been strong, the macro data had positively surprised and, more recently, consumer spending in key economies has definitively inflected higher. European corporate earnings and margins have grown more than in the United States on a year-over-year basis.  

The question begs: Where will European consumption be focused? There are a few interesting differences worth highlighting when compared to U.S. reopening trends. Interestingly, the focus on travel, dining, and events is higher than we saw in the United States, which would broadly corroborate our view that the K-shaped recovery could well invert in Europe, as well. Stronger signaling in Europe than in the United States could be due to the relative severity of the lockdowns, but either way, we’re receiving multiple signals that the recovery is under way, as well as some granular insight into where the highest levels of activity could be. 

Europe: selected retail sales indexes

Chart showing retail sales in Germany, the U.K., Italy, and the Euro Zone from February 2020 to March 2021 (rebased to 100). Retail sales have increased since the beginning of 2021 in each country/region.
Source: Manulife Investment Management, Macrobond, as of March 2021. Rebased to 100, where 100 = February 2020.

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Erica Camilleri

Erica Camilleri, 

Global Macro Analyst, Multi-Asset Solutions Team

Manulife Investment Management

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Frances Donald

Frances Donald, 

Global Chief Economist and Strategist, Multi-Asset Solutions Team

Manulife Investment Management

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