Omicron variant: ‘The economic impact of COVID seems to be diminishing,’ economist says

S&P Global Ratings Global Chief Economist Paul Gruenwald joins Yahoo Finance Live to assess recent economic woes on markets stemming from the Omicron variant and Fed chairman Jerome Powell's testimony.

Video transcript

- --down. Let's talk about the broader economy now, with Paul Gruenwald. He is Global Chief Economist at S&P Global Ratings. And like many of your peers, Paul, in the economics and strategy world, you guys have been busy working on your outlooks for 2022 and, I think, 2021, through what we hope is one final curveball in the form of omicron.

So you did factor that into your discussion and your outlook. But talk to me about how you factored it in, and what you think the implications are for global growth.

PAUL GRUENWALD: Hi Julie. Thanks for having me on the show. You're right, we just finished what we call our credit conditions round, which is our quarterly forecasting round, with a fresh view of the global macro credit scene. Yeah, omicron, it's a little bit early. What we do know from the data during the year is that the economic impact of the virus has been diminishing.

So for a given amount of infections, we know that, because of vaccinations, and governments having a little bit more tolerance for the numbers, the impact on lockdowns from a certain number of infections has dropped. And then given a certain amount of lockdowns, you know, households and firms are learning to live with the virus, so the impact on the economy has been falling.

So the mapping from the virus, to the lockdown, to the macro world has been diminishing. That doesn't mean we can't get a shock. So omicron's going to be a new shock. We don't know yet how serious it's going to be. But I think the good news is, the economic impact of COVID seems to be diminishing, and we'll see what happens over the next couple of weeks when we get more health data.

But that's about all we can say in this round. We just don't really know enough to yet confidently map that into some macro numbers.

- Paul, don't laugh me off my own show here, but I read my first piece this morning of someone, a strategist, looking for a potential recession in 2023. I mean, do you see any of that recession risk starting to creep up in the markets? And would that be a cause, if we do go into recession by 2023 for whatever reason, would that be driven by higher interest rates, and a tightening policy by the Fed?

PAUL GRUENWALD: Yeah. I don't think we see a recession in the US or anywhere else in the next couple of years. Let's remember, we're setting a three decade high for growth this year in the US, even though we've just lowered our forecast to 5 and 1/2. We do expect economies to slow, right?

So we knew we would come out of the depths of COVID quickly. We know that there are inflation fears, and that central banks are moving off of the zero lower bounds and starting to withdraw accommodation, et cetera. But you know, we would need a pretty significant macro or credit shock to go into recession territory.

So for us, the view is still kind of this reasonably orderly reflation and exit from COVID. But it would take a pretty big, as I said, surprise to take us into negative growth for a couple of quarters, which is the standard market definition of a recession.

BRIAN CHEUNG: But Paul, it's Brian Cheung here. You talk about the central banks there, your note kind of made a point of the fact that some central banks, especially in the emerging markets, are hiking rates, and some of them even aggressively. Is there a concern that, especially with the omicron variant kind of presenting the reminder that, hey, there are other variants that could come out here that could slow economic activity, especially in those emerging markets that might even spill over to the advanced economies, that the central banks could be positioning themselves for a little bit of a pivot that they might have to make later down the line.

PAUL GRUENWALD: Yeah, Brian, maybe a bit too early to make that call. I mean, we're aware that some of these inflation pressures we're looking at, whether they're from oil or supply chains, are eventually going to start fading. So one of the risks, it's not a main risk, is that central banks kind of tighten too much in the near term. I wouldn't put that as a top risk. And again, that depends on how big the impact of omicron is.

But I think the focus of most central banks is on inflation, keeping inflation under control, making sure medium term expectations are pretty well anchored, and keeping the economy at an even keel close to full employment. I think they've got, maybe, one eye on potential downside risk to slow the economy, but I don't think that's the major focus right now.

- So Paul, I'm looking at your forecast for the next several years. So this year, you're looking for global GDP growth of 5.7%, 4.2% in 2022, and then looking at about 3.5% for 2023, 2024. Here in the US, 5.5% this year, 3.9% next year.

Given what we heard from Jay Powell yesterday, and given the outlook for growth, is it the right thing, as he seemed to indicate, to pull forward the end of bond buying and the beginning of rate increases?

PAUL GRUENWALD: Yeah. Well, we've been signaling the risk that the Fed may have to move earlier. And we think the key variable there is the labor market. We got the ADP this morning, another strong number. We don't know, we won't know until Friday for the jobs report whether we're pulling more people into the labor force and get the participation rate up. But you know, the Fed said they've got their inflation objective met, that shouldn't be a big surprise.

But they're still waiting to achieve the labor market objective, which is maximum employment. And they think the unemployment rate can be pushed below 4%, keeping wage growth in check. But that's the big issue right now. Because we're seeing a very hot economy, we're seeing wage growth, and the unemployment rate is still 4.6%.

So given what we're seeing with another strong employment number, you just pointed to some strong manufacturing number. Maybe the labor market is tighter than the Fed thinks, and that's the reason to start to move earlier. So as you said, now it looks like we're going to get an acceleration of tapering. We're still going to start this month, but maybe end it early. And that kind of clears the deck for a rate rise.

We've got it in the third quarter of next year, but I think the risk is that could even come earlier because the Fed has now accelerated the pace of tapering.

BRIAN CHEUNG: Paul, I've got a bit of a big picture question here, but how much humility should there be in broad economic forecasts right now, when we hear the Fed chairman come out yesterday and say, we're going to retire using the word transitory, because inflation ended up being stickier than we had expected, and it's possible that this could be more persistent than we had expected?

Maybe that's just because of the dynamics at play here, which is that this is, first and foremost, primarily an epidemiological issue that economists maybe aren't able to fit into a Stata model.

PAUL GRUENWALD: Well, there should be lots of humility, right? I was listening into a webinar yesterday where a very prominent economist said, no one should be celebrating about their inflation forecasts in 2021. The entire profession missed it on the low side. You're right. We've never gone through a pandemic in our professional lifetime, so we don't have any experience forecasting this sort of thing.

And then we've been playing semantics with the word transitory over the last couple of months, and I think we finally just threw in the towel yesterday on transitory. So yeah, there's a good dose of humility to go around. But we still need to get the forecast as correct as possible. The Fed needs to do its job, and achieve its dual mandate.

But yeah, maybe we retire the word transitory for now, and just focus on the dynamics, and the wage market, and getting the policy rate right, and keeping the economy at a pretty good keel, right? We've had a pretty good year this year. I think that's part of what's generating the inflation surprise. But try to continue that momentum into 2022 and beyond.

- Transitory should have been retired three or four months ago. But we'll leave it there for right now, Paul Gruenwald. Global Chief Economist at S&P Global Ratings. Always good to see you.