Multi-Asset Solutions Monthly Strategy Report
Global markets and multi-asset portfolios
EXHIBIT 1: MAS ASSET CLASS VIEWS FROM DEC STRATEGY SUMMIT
MARKETS REACT AS GROWTH RISKS SHIFT TO THE UPSIDE
As we look across the global economy, we see growing evidence that developed economies are proving more resilient to lockdown restrictions in 2021 than they did in early 2020. Current forms of lockdown are also doing less damage than many observers feared. Case in point: In 4Q 2020, the UK’s GDP print was positive, despite tighter restrictions. This resilience, first seen in Asian economies, is now evident in developed economies, eroding certain downside risks we had foreseen on the horizon.
The U.S. economy wobbled at the end of 2020. Consumer spending edged down in November and December and employment declined in the final four weeks of the year. Nonetheless, fourth quarter GDP climbed a solid 4% quarter-over-quarter, seasonally annual adjusted rate (q/q, saar) thanks to support from business capex and residential investment as well as strong consumption in October. The drop in employment, meanwhile, mostly owed to low-paying restaurant jobs—higher-wage posts actually rose. In turn, the rising trend in household labor income remained in place.
That favorable backdrop for households interacted with a new round of stimulus checks at the start of 2021 to produce a surge in retail sales in January. On the whole, it appears that consumer spending reaccelerated in early 2021, and we expect ongoing strength in household demand to support above-trend U.S. growth for the next few quarters.
Vaccine rollouts picking up pace
Rapid and widespread dissemination of vaccines is setting the foundation for strong growth momentum once economies start reopening—another unambiguously positive development. Vaccine rollouts have been particularly brisk across the U.S. and UK. Latest U.S. data indicate that if the current pace of dose administration persists, close to 75% of the U.S. population aged 16 and older could be fully vaccinated by early September. What’s more, that pace could accelerate in the coming months. Experts now project that 16% of the global population could be vaccinated by the end of 2021. Critically, the projected rollout is likely to be broad-based across geographies. If it is, that would be a remarkable achievement against a deadly virus that only emerged about a year ago.
We note other economic tailwinds heading into the second quarter. The U.S. Congress, working with the new Biden administration, is now preparing another round of fiscal stimulus that will likely be approved within the next month. Although it will fall short of the White House’s original proposal, it seems set to top USD1 trillion, or more than 4% of GDP. We do not expect the stimulus to deliver an equivalently sized boost to the economy. That’s partly because some of the stimulus will likely be disbursed over time--such as in aid to state and local governments--and partly because we assign fairly low multipliers to some aspects of the spending. Still, we are revising upward our U.S. growth forecast for this year by about a percentage point and now think GDP will climb at roughly a 6% pace in 2021.
We see the risk to our expectations tilted to the high side. The economy remains mostly in early-cycle mode. Although it is progressing quickly through that phase of the expansion, we do not see significant near-term probability of a recession—outside of the somewhat unquantifiable remaining threats related to the virus. Nor do we envision a material pullback in private sector spending. Growth could plausibly exceed our projections in two ways. First, fiscal stimulus could prove more effective (that is, display higher multipliers) than we think. Second, while the saving rate will likely drift lower over time, we do not expect households to spend much of the stockpile of “excess savings” they have accumulated over the past year. If they use the money to bring their balance sheets back toward pre-shock levels, the economy could run considerably hotter.
Looking ahead, we expect the accommodative policy backdrop to support asset markets. At their March meeting, Federal Reserve (Fed) policymakers are set to revise upward their own near-term growth outlook, following their December forecast of a 4.2% GDP gain in 2021. That revision, though, seems unlikely to trigger any change in policy settings or forward guidance. Most Federal Open Market Committee (FOMC) members assign a low coefficient to slack in the economy when making inflation forecasts. Moreover, the Fed no longer places much weight on its own inflation forecasts and instead prioritizes realized inflation, which remains moderate. Finally, last year’s adoption of an average inflation targeting framework implies greater willingness to let price increases move higher over time, partly to head off the possibility that the pandemic shock, coming after a decade of below-target outcomes, pushes down inflation expectations and makes the eventual achievement of the Fed’s goal that much harder.
Expectations that economic activity will rebound in the second half have fueled a global reflation narrative among market participants that continued apace this month. Risk assets showed continued strength across multiple asset classes, bolstered by strong Q4 earnings results and economic activity more resilient than expected. Notably, within equities, cyclical markets outperformed. In keeping with this reflation trade, yields on global bond markets have risen while yield curves steepened. Ten-year U.S. Treasury (UST) yields led this move higher; yields are now above 1.2% and the yield curve slope is back to 2017 levels.
ASSET ALLOCATION IMPLICATIONS
We maintain a pro-risk stance with a positive outlook on the global economy in 2021. The recent fiscal stimulus measures reinforce our view that the U.S. economy will grow, if anything, significantly above trend this year. Better vaccine rollouts and strengthening economic resilience amid restrictions have come together to reduce negative tail risks and are simultaneously interacting to introduce upside risks to our outlook.
Bond yields have recently risen in line with the upgrade to the growth outlook and particularly on news of larger proposed U.S. fiscal stimulus. We expect a further gradual rise in yields that reflects the better growth outlook and the improving distribution of risks for the economy. We now expect the yield on the 10-year UST to trade in a higher range of 1.20%–1.60% (vs 1.0%–1.4% previously). This reflects more substantial U.S. fiscal stimulus and a more favorable economic backdrop than we had expected. Bond markets have already repriced an improved growth outlook to a large degree —10-year UST yields rose over 70 basis points (bps) since November. Inflation pricing has also moved sharply (Exhibit 1) to price in the improving economic backdrop with 5y5y inflation swaps now as high as 2.4%and the gap between market expectations converging to long term economist forecasts. From here we expect more moderate yield moves.
Inflation pricing has moved sharply to price in the improving economic backdrop
EXHIBIT 1: 10-YEAR MARKET IMPLIED INFLATION BREAKEVENS VS. ECONOMIST FORECASTS FOR 10-YEAR INFLATION EXPECTATIONS (CPI)