2Q 2021 bonds: where are the opportunities as inflation looms?
We explore the bond themes and opportunities 2Q 2021 as inflation picks up.
Recently, investors have been witnessing political events in the world’s two largest economies that could have quite a profound impact on global economic development in the next four to five years. They are:
The US presidential race has come to an end and now there's a new administration-in-waiting. Come January 2021, the US government may have a White House and the upper chamber of Congress on opposing sides. That could bring some challenges to governing in the medium term1.
On the other hand, China's economic policies and development priorities for the next five years are relatively straight-forward. So as we await the final tally of the US elections, we share our views on the investment implications from these events, and the potential opportunities that could emerge.
Public health crisis and economic recovery
The most urgent task for both China and the US is tackling the resurgence of infections and mitigating the economic fallout from the public health crisis.
As yet, statistics show that China has successfully contained the health crisis. Economic recovery has been gradual, and on a growth trajectory since the second quarter. The economy grew 4.9% in the third quarter2 and domestic retail sales and consumption have also begun to show positive growth. Although China’s export performance is still affected by external factors, the economic stimulus provided by the People's Bank of China and the government is relatively conservative. China has also continued to focus on structural reforms.
In contrast, many US cities may have to reimpose mobility restrictions and closure of services amid a resurgence of infections. At the same time, Congress has not passed a new round of measures to support businesses and low- and middle-income families, further threatening economic growth in the fourth quarter. As such, more support measures are needed, alongside a better infection control strategy1.
Governments around the world are in for a long fight as the health crisis is likened to a marathon rather than a sprint. Even if a vaccine is successfully developed in the short term, there’s still the need to take into account the amount of time required to manufacture and distribute the vaccines. Therefore, the current preventive and control policy may last for some time. Utilising limited financial resources to bring about the most effective economic support will be a challenge for many governments1.
Although the Federal Reserve’s quantitative easing is keeping rates low for longer, we believe the next US government still needs an effective plan to increase revenue and reduce expenditures, thus adjusting government liabilities to more reasonable levels to shore up investor confidence in US Treasuries.
China to shift focus on infrastructure investment
Infrastructure development has long been the backbone of China's economic growth in the past three decades. We believe that infrastructure development will still play a key role under the new economic blueprint. But the types of projects may change. In the past, the focus was on construction of transportation and logistics infrastructure, such as roads, railways, ports and airports. In the next five to ten years, the focus will be the development of technology- and energy-related infrastructure1.
The evolving US-China trade relationship has prompted the Chinese government to accelerate development of its technology sector. China also recently announced a plan for net-zero carbon emissions before 20603. The move has helped raise awareness of sustainability and could accelerate the shift from fossil fuels to renewable energy sources such as wind and solar power. We believe this could open up additional potential investment opportunities in these sectors4.
Infrastructure development has also been a policy goal of recent US administrations. However, limited financial resources may constrain government investment in this sector. Additionally, infrastructure investment in the US is generally approved and funded by state and local governments rather than on a federal level. With most state governments facing severe fiscal deficits, any infrastructure project proposal would likely involve closer scrutiny and lengthy debates.
The revival of “Made in the USA”
During the elections, the policy pitches have focused a lot of attention on incentivising American companies to bring manufacturing back to the US. For labour-intensive manufacturing, this may not be cost-effective1. In addition, relatively more attractive tax concessions are needed before companies would consider bringing production back from overseas.
From a Chinese perspective, traditional manufacturing over the next five to ten years may move overseas to Southeast Asia or other emerging markets because of rising cost. But if China’s economic upgrading can be carried out relatively successfully, the loss of traditional manufacturing industries could have limited impact on China's economy1. The repositioning of the global supply chain from China to other emerging markets may also open up potential investment opportunities4.
Market volatility will likely persist as these political events unfold in China and the US. Instead of focusing on the short-term fluctuations, investors could consider taking a longer investment time horizon as they seek potential investment opportunities in these uncertain times.