Global macro outlook: Virus versus vaccine

Sponsored article: Salman Ahmed argues monetary policy, a global vaccine rollout and fiscal stimulus are likely to put “upward pressure” on bond yields.

Much like the latter half of 2020, we expect a strong business cycle dichotomy to dominate markets in the first half of 2021. What does this dichotomy consist of? Well, look at it this way, Covid-19 case rates are skyrocketing again across much of the West, lockdown stringency is on the rise across most of Europe and Google mobility data shows us that even the US is starting to see a slowdown in activity.

And yet global equity markets are at, or near, all-time highs and global credit market spreads are approaching their pre-Covid crisis tights.

Dichotomy

What explains this dichotomy then? Well, one has to remember that markets are, at their essence, a machine for converting expectations of the future into prices today. As a result, while economic activity today is likely to be weak, economic activity next year, and, indeed, later this year, is likely to be significantly stronger.

This is driven by a number of macro factors, but the most significant one of course is the emergence of a number of credible and effective Covid -19 vaccines that are diversified across both platform and supplier. Indeed, the developed world is likely to have secured 100% of their vaccine requirement by Q3 this year, making the rollout of the vaccine to individual arms the key unknown.

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Additionally, monetary policy is very likely to remain deeply accommodative for the rest of this year. Real neutral rates around the world will continue to fall as inflation emerges and, with central banks from the Fed to the ECB promising to keep the QE tabs on in the midst of a large global rebound, the macro policy support for markets and the economy will remain strong.

On the policy front, the final piece of the puzzle in the DM world is the Democrats taking the Senate in the US with a one vote majority. From a macro policy perspective, the most significant implication of this is additional fiscal stimulus on top of the deal which was approved in December.

Overall, we expect an additional $1.5-3trn of gross spending over the next four years to be unlocked by Democratic control over the Senate, with a front-loaded dose of further Covid-19 relief to be enacted in early 2021 (our expectation is a minimum of $600bn, in addition to the already confirmed $900bln).

Bond yields

Looking away from developed markets, we see China’s growth as likely to remain robust with no signs yet of overheating and underlining the importance of virus containment.

Looking across broader emerging market countries, we see the potential for output gaps to narrow in 2021 as growth bounces back and vaccines are deployed, if at a slower rate than in DMs.

Putting this all together then, in terms of markets, these various reflationary impulses coming from vaccine rollout, monetary policy accommodation, and additional fiscal stimulus, are likely to put upward pressure on bond yields which are already starting to break recent ranges.

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However, this rise is unlikely to be smooth, as volatility is likely to notch up significantly in the near-term as expectations of additional fiscal easing fight against a surging virus and continued QE from the Fed. For equities, we see these developments are best expressed through the prism of sectoral and style rotation, with small-cap and cyclical sectors likely to benefit most.

With such a constructive outlook, it’s always important to lay out what the potential risks are to one’s view. Below are what we view to be the key macro risks for 2021 and beyond:

1. Credibility of monetary policy. We view this as the top risk for 2021, with the potential for a taper tantrum—in the style of the Bernanke 2013 tantrum—a real possibility;
2. Virus intensification, vaccine uptake, mutation driven vaccine delays. Clearly significant risks, but difficult to handicap;
3. The geopolitics of US-China decoupling. This is unlikely to be top of mind for President-elect Biden and his team of senior foreign policy advisors for much of 2021, but with the rise of China near unstoppable it’s unlikely to be too far from the surface.
4. China financial stability: A more medium-term risk, but one that deserves to be kept on the radar given the potential global ramifications.

Salman Ahmed is global head of macro at Fidelity International.

Photo by Adam Nieścioruk on Unsplash