The beginning of 2021 continued to be volatile for both equity and fixed income markets with market sentiment driven by rising government bond yields.
Yields for 10-year Treasuries increased rapidly to over 1.7% causing a drop in both equity and bond prices. These increases were expected to occur gradually throughout the year, but instead occurred over the course of a few weeks. They were in part due to the concerns around inflation because of the large size of the US relief package combined with the reopening of the economy and in part a return to pre-pandemic yield levels. We believe that most of the increases in Treasury yields have now occurred.
The acceleration of the vaccine rollout, the reduction of restrictions across the US and UK, the reopening of markets, continued quantitative easing and furlough programmes, pent up consumer demand, and new large government stimulus packages created concerns around inflation, an overheated economy, and the potential for interest rate hikes.
In response to these concerns, central banks have said that they will keep interest rate lower for longer and are happy to let the economy run ‘hot’ while economies are still recovering. Overall, expectations are that the economic recovery will be stronger than inflationary worries.
The coronavirus and the state of the economy are intrinsically linked. There are still risks in the form of delayed vaccine rollouts, as seen in Europe with a third coronavirus wave and newly introduced lockdowns, and of new variants which are resistant to current vaccines. Conversely, successful vaccine rollouts have shown to bring down the R-number, coronavirus cases and hospitalisations, and the end of restrictions. Economies that are experiencing a surge in cases will be slower to return to normal, but as the vaccine is distributed and larger percentages of populations are inoculated, recovery should eventually follow.
In the UK, the NHS is progressing through its Herculean efforts with the coronavirus vaccine rollout. More than half of UK adults have already received their first dose of the vaccine and we are on track to offer the vaccine to all adults by the end of July. With furlough schemes and quantitative easing continuing, and as restrictions ease, schools and shops reopen, pent-up demand should boost consumer spending and investor sentiment.
The IMF has lifted their global growth forecast for 2021 from 5.5% to 6% as the vaccine rollout accelerates throughout the world and advanced economies continue to spend aggressively with the US and China driving the recovery. The IMF projects expected growth of 6.4% for the US after a 3.5% contraction last year and 8.4% for China up from 8.1% earlier this year.
The US relief package in December provided a quick boost to the economy with a surge in credit card spending apparent by January. The new $1.9 trillion Biden Covid-19 relief package was again sent directly to families and is expected to be spent quickly, help small businesses, and deliver a strong boost within the US economy.
With a renewed statement of support from the Fed to not raise interest rates until 2023 when they are confident in the recovery of the labour market, volatility in the past few weeks has returned for the first time to pre-pandemic levels in the US as shown in the following graph.
The VIX is a measure of volatility by the Chicago Board Options Exchange which represents the expectations of a 30-day forward projection of volatility on the S&P 500. For a few days in Feb and at the end of March, the VIX dropped below 20 for the first time since the end of February 2020.
The Fed has also modified their inflation target from a level of 2% to an average of 2%. There may be a temporary increase in prices due to supply issues, but to act the Fed would have to be convinced that any price increases are transitionary instead of temporary.
The latest employment numbers in the US have been much higher than expected, including statistics for women and minorities. These are some of the much broader employment measures the Fed is utilising to ensure a recovered economy. They are willing to run the economy ‘hotter’ than normal as inflation was historically low before the pandemic even with high employment numbers. The Fed have stated that in the short term they are more concerned about supporting the labour market than inflation.
The US Treasury has stated that Biden’s tax proposals would generate around $2.5 trillion over 15 years to help pay for the 8 years of infrastructure spending. Republicans have proposed an alternative infrastructure plan which is not as broad in its scope. Both proposals are still works in progress. If this money is spent wisely on quality, effective sustainable infrastructure, and other government projects, this could generate a higher long-term growth rate for the US economy.
Overall, the high amount of consumer saving, huge deficit spending, expanded vaccine distribution, continued quantitative easing and the new Biden administration’s $2.3 trillion infrastructure plan alongside low inflation and interest rates could lead to a surge in economic growth which could last until 2023 and filter through to other trading partners.
Our asset allocation has continued to overweight global, US and UK markets due to large stimulus packages and successful vaccine rollouts. Our next highest allocations are to the emerging markets and the Pacific as we expect these areas to benefit from increased trade and the continued rise of both China and the US. We expect equity markets to be poised for growth over the next year as economies reopen and government stimulus continues.