Vaccination sets the stage for the next phase of the egg and spoon race

The egg and spoon race is a staple competition of many schools’ sports day. Each team puts an egg on a spoon and has a relay race to see which team can have all the team members run through a course in the shortest amount of time. Some kids are good, as if the egg is glued to the spoon. Some need more time, especially if they drop the egg and it rolls away. 

The U.S. and UK in a good position to catch up

A year into the COVID-19 pandemic, the vaccines are now setting the stage for the next challenge in the return to economic recovery. The U.S. struggled to contain the outbreak over the past 12 months, but it has excelled in the vaccination front. By the end of March, 28% of the population had already received at least one dose of the vaccine. U.S. President Joe Biden has therefore doubled his target and aims to administer 200 million doses of vaccines in his first 100 days as president. At this pace, over half of the U.S. population should gain protection against the virus by this summer, either via vaccination or infection. The UK has also made very good progress with over 45% of the population getting at least the first dose.

What’s more important is that data confirms that the vaccines have helped to reduce the number and severity of infections. This is already allowing the U.S. to gradually reopen its services sector, such as air travel and sports events. Combined with the USD 1.9trillion fiscal package, this would greatly facilitate the economic recovery that should boost growth in 2Q and 3Q 2021.

For the rest of the world, vaccination progress is mixed at best. In the European Union (EU), with a population of over 440 million, only 12% has received at least one dose. The progress is delayed by confusion over distribution of vaccines and public skepticism. This coincides with a fresh wave of outbreaks in France, Germany and other European countries, leading to another round of lockdown. This means the EU’s recovery will lag the U.S., and potentially miss out on the peak summer travel season. 

Progress is also slow in Asia. Singapore is the only country in Asia where more than 10% of its population has received at least one jab. This is partly due to the region’s relatively successful containment of the pandemic. Hence, the general public feels less urgency to be vaccinated. Some governments have also been slow in securing sufficient vaccines to cover the full population.

One positive for Asian economies is that the export sector remains very robust, and it is likely to maintain such strength as the global economic recovery takes hold. However, some economies, such as Hong Kong, Singapore and Thailand, are also dependent on people flow, either in tourism or business travel. Some form of vaccine passport or travel bubbles will help to facilitate this rebound, but it remains unclear whether this will take place in time for the summer holiday. 

The Fed stays dovish while China looks to normalize

Investors are still worried about the combination of economic recovery and fiscal stimulus that could lead to a period of high inflation. This has already prompted a strong rise in U.S. Treasury (UST) yields in 1Q 2021. The March Federal Open Market Committee (FOMC) meeting provided an update on the Federal Reserve’s (Fed) view of the economy and policy outlook. While the FOMC has revised its growth and inflation forecasts higher for 2021, both indicators are expected to ease back toward the long-term trend in 2022. While inflation could push above the Fed’s target of 2% in 2021, the median for the first policy rate hike remains at after 2023. A few FOMC members providing the forecasts have pushed forward the timing of the first hike to 2023, in line with the futures market, and this trend could continue as the job market recovers.

Nonetheless, the key takeaway from the meeting and forecasts is that the Fed still sees inflation pick up to be a temporary phenomenon and it will eventually ease back towards its target. It remains to be seen whether investors will be convinced by this view. We still expect the risk of UST yields to remain on the upside in the next 12 to 18 months as real yields move higher in line with the broad economy.

The Chinese economy has already made comprehensive recovery, posting 2.3% real GDP growth in 2020. This led the government and central bank to aim for policy normalization, as indicated in its annual National People’s Congress in March. It aims for “at least” 6% GDP growth, which is conservative given the low base from 2020. It also aims for credit growth to expand at a similar rate as nominal GDP growth. More importantly, credit conditions for the real estate sector could be tightened again to limit speculation and property price rise. These policy measures have prompted the onshore equity market to correct, especially the technology sector, which has seen strong performance in 2020 with relatively stretched valuations. The cyclical sector, and “old economy” stocks, suffered less in this bout of correction.

The pro-risk tilt still makes sense

We still see the rise in UST yields to be a signal of the economy getting better, rather than acting as a constraint to growth and corporate earnings. This is reflected in the respectable performance in equities in March. The S&P 500 was up 2.5% and Euro Stoxx 50 was up 5.8%. For some time, we have argued that inflation and bond yields rising from a low level have correlated with positive performance with equities. Some inflation actually helps to improve pricing power and contribute to corporate earnings. We expect the next stage of equity returns could come from earnings growth, rather than valuation re-rating. In Asia, while Chinese equities came under pressure due to policy normalization concerns, the rest of the region posted modest gains in March.

Moreover, we saw the ongoing rotation towards cyclical sectors that would benefit from economic recovery. Rising yields are expected to improve the interest margin of banks and improve return for insurance companies and asset managers. The rise in commodity prices are also helpful to restore profitability, even though slower credit growth in China could cap the upside for industrial metals. The Organization of the Petroleum Exporting Countries’s agreement to gradually increase output would also limit how far oil prices could rise.

This contrasts with fixed income assets that still struggled to make a positive return in March. Rising yields obviously put pressure on government bonds in the U.S. and European markets. For emerging market debt, the rebound in the U.S. dollar has put more pressure on local currency debt than hard currency. U.S. high yield corporate debt was able to generate a small positive return due to credit spread compression (17bps) and its relatively higher yield to offset the losses from duration. We expect short duration and high yield would still be the preferred position in fixed income in coming quarters given the upside risks to government bond yields. 

Global economy:

• Global manufacturing survey data continued to reflect upbeat sentiment in many countries. In particular, the Eurozone Purchasing Managers’ Index hit an all-time high despite news of slower vaccine distributions and re-imposed mobility restrictions, although the timing of the surveys may have had some bearing on this. In the U.S., a slew of data releases also showed continued improvement in the economy. Nonfarm payrolls surged 916K, the biggest gain since last August and well above market consensus.
  (GTMA P. 13, 26)
• The U.S. Congress successfully passed its USD 1.9trillion budget stimulus plan, adding to growth momentum and feeding inflation fears. In the March FOMC meeting, the Fed attempted to quell these concerns. It voted to maintain the current fed funds target rate and reaffirmed its asset purchase commitments until the committee feels “substantial further progress” has been made towards its inflation and employment goals. The Fed’s “dot plot” suggests no interest rate movements through 2023, but on average, committee members appear to have shifted slightly more hawkish.
  (GTMA P. 27-29)

Equities:

• Equity markets continued to power ahead in March, along with the rotation out of growth into value stocks. The S&P 500 total return index returned +4.4%, while the NASDAQ returned +0.5%. The large proportion of cyclical names in Europe also proved a boon for the European market, with the Stoxx 50 and FTSE 100 returning +7.9% and +4.2%, respectively.
  (GTMA P. 31)
• Tight monetary conditions continued to act as a drag on China equity sentiment and put pressure on valuations as the CSI 300 total return index fell 6.8%. The pressure on risk sentiment owing to rising U.S. bond yields also spilt over into Asia and emerging markets. The MSCI APAC ex-Japan and MSCI Emerging Markets total return indices fell 2.1% and 1.5%, respectively.
  (GTMA P. 31, 35, 39)

Fixed income:

• The Fed’s commitment to letting the economy run hot continued to drive the sell-off in bonds and push 10-year UST yields higher to 1.7%. In Europe, markets seemed relatively more assured by the European Central Bank’s bond purchase commitments. 10-year German bond yields remained stable at -0.3% as of end-March. 
  (GTMA P. 54, 55)
• Credit spreads tightened slightly across the board. Improving economic data suggests default risks are already past their peak and that returns will be driven primarily by carry moving forward. Where and how much risk to take in the credit space should drive investors’ decisions within the asset class.
  (GTMA P. 51, 53, 62)

Other assets:

• Oil prices traded within a narrow range as Brent crude ended March at USD 64.14/barrel. The rise in government bond yields continued to weigh on gold, as the non-interest paying asset has become relatively less attractive. Gold prices fell to USD 1,715/ozt.
  (GTMA P. 72-74)
• The U.S. dollar index rose 2.6% over March, reaching a one-year high against the yen as investors bet that fiscal stimulus and aggressive vaccinations will boost U.S. recovery. In emerging markets, the Turkish lira slid 11.6% against the U.S. dollar after the sudden removal of a hawkish central bank governor, in favor of a more dovish replacement. Most emerging currencies also experienced a slump in March, although this was due more to the strength of the U.S. dollar rather than from any spillover effects from the Turkey incident.
  (GTMA P. 69, 70)