The road to net zero: Three-minute macro

The energy transition won’t be cheap

We’ve been paying close attention to the events at the 2021 United Nations Climate Change Conference (COP26), particularly because of one of its main goals: to “secure global net zero by mid-century and keep 1.5 degrees within reach.” We’ve written about tight supply in the crude market and the downstream implications that rising energy prices can have on the consumer and the broader economy. Another side of this trend is that underinvestment in dirty energy has allowed more capital to be allocated to the clean energy transition.

While investment into clean energy has increased, it’s becoming increasingly clear that it’s not enough. According to Bloomberg, in 2020, $501 billion was committed to decarbonization, with $304 billion specifically allocated to renewable energy sources; this still pales in comparison to what will be required to reach a net zero economy (NZE) by 2050. It’s clear that an NZE starts with energy transition: Over three-quarters of greenhouse gases are energy related, with the balance stemming from agriculture, land use, and other nonenergy sources. The International Energy Association estimates that to reach net zero emission by 2050, annual clean energy investment worldwide will need to increase to roughly $4 trillion. A move to aggressively increase capital to the space would undoubtedly have an impact on growth: IMF research has empirically proven that the economic multipliers for green energy investment are higher than for non-eco-friendly investments and that investment in the space also has a greater long-term impact.

We know that environmental, social, and governance (ESG) factors play an increasingly important role in the formulation of investment outlooks, so we’ll undoubtedly be keeping the energy transition on our radar and writing more about its potential impacts on global growth in the near future. 

Record investment in the energy transition in 2020

Global investment in the energy transition (US$, billions)

Source: BloombergNEF, as of 2021. 

Can supply chains get back to normal?

What do jobless claims, rising prices, housing, the auto segment, and freight charges all have in common? As far as economists are concerned, they all tie into a critical theme that’s been at the heart of jagged shifts in macro outlook base cases and, by extension, investment themes: supply chain disruptions, one of our key macro anchors.

In our case, these disruptions affect our outlook in two ways: First, breaks in the supply chain have put upward pressure on prices, as evidenced by persistently higher inflation and key central banks beginning to question how transitory the inflation really is. Second, the inability to actually receive the product being sold could effectively constrain growth.

We don’t expect an even and consistent unwind of all disruptions simultaneously and, in some cases, such as days in port, there have been reversals from what looked like hopeful trends; however, there are indicators worth watching for progress. Specifically:

• Various ports have begun to extend their operating hours. Progress around wait times at key ports has proven erratic, with promising declines having been recently reversed, but movement here would again be welcome.
• Taiwanese chip manufacturing has started to improve, which will be a relief in areas such as the auto segment.
• Months’ supply for new homes has moved back toward a balanced level (existing home sales are extremely stretched but have hooked higher).

It’s early days, but the rolloff of unemployment benefits could alleviate current labor market dynamics over the next few months.

Ships are still the kink in the supply chain

Average days at anchor and berth at Los Angeles Port (7-day moving average)

Source: Port of Los Angeles, Macrobond, Manulife Investment Management, as of November 8, 2021. 

A potential pivot for the Fed

Our view is that the U.S. Federal Reserve (Fed)—and most central banks, actually—will have to pivot away from more hawkish/confident data toward a more dovish/cautious tone in early 2022; in fact, in our view, it’s entirely possible that the Fed cannot hike at all in 2022. Why?

• In the first half of 2022, growth data looks as though it will be weak and disappointing. Declining PMIs, fiscal stimulus acting as a headwind, uninspiring consumer activity, supply chain disruptions limiting inventory rebuilds, and China weighing on global trade are our baseline. The second half of 2022 should be an improvement as CapEx accelerates, but we’ll still likely be a long way from the escape velocity many had hoped for last year.
• Our inflation forecasts suggest that while supply chain disruptions remain elevated, inflationary pressures will fade quickly throughout 2022, particularly on the goods side of the equation, meaning less of an urgency to address inflation. Perhaps more importantly, the inflation that will persist is likely to remain global and supply-side driven, meaning it’s not particularly sensitive to interest-rate policy and is therefore unlikely to incur a response from central banks.
• Yield curves haven’t responded well to global policy tightening and have flattened, especially for countries such as Canada and the United Kingdom. Since June, U.S. markets have increasingly front loaded rate hike expectations while forecasting fewer total rate hikes, and yet yields at the long-end of the curve are falling, suggesting a waning excitement about a game changing paradigm shift for long-term growth. This reduces policy options for the Fed (and other central banks) and suggests that the market increasingly views central bank activity as approaching policy mistake territory.

This potential pivot may not occur until early 2022, as there’s still ground to cover. At September’s FOMC meeting, half of the FOMC saw a rate hike in 2022 and several on the committee wanted a faster pace of tapering. Meanwhile, inflation is still uncomfortably high, financial conditions are loose, and the U.S. dollar is mostly well behaved. To top it off, Chair Powell is up for reappointment just as the discourse around inflationary pressures has taken on an increasingly political tone.

When it arrives, convincing the market that it is indeed shifting gears may be challenging for the Fed. Chair Powell can lean on traditional communication channels and could continue to emphasize the temporary nature of inflation and that central banks shouldn’t overreact to transitory supply shocks. But, ultimately, it might take a change in the dot plot to meaningfully steepen the curve, and we’re unlikely to see that until U.S. economic data veers off course in a more visible manner. The Fed could also slow the pace of asset purchase tapering to send a message—an option they left open when announcing the taper in November—although that’s likely a last resort. And then there’s the possibility that when his term expires in February, Chair Powell will be replaced with someone considered far more dovish and focused on labor.

If and when this pivot comes, we would view that consistent with the idea that the cycle can be extended, yield curves can steepen again, and cyclical trades will come back in favor. Until then, the road for these trades might be bumpier.

Yield curves are flattening globally

30-year minus 2-year yield (basis points)

Source: Manulife Investment Management, Bloomberg, as of November 8, 2021.