Client Update - 26th March 2021
The vaccine rollout has generated genuine optimism despite still significant risks associated with the virus. With the reopening of shuttered businesses, and increased mobility, there is clear potential for an economic boom from the second half of 2021, although the market over the short term is wrestling to come to terms with higher inflation.
Central to that optimism has been US President Joe Biden’s $1.9trn stimulus package, which among its measures will put $1,400 cash into the hands of most Americans. It has triggered warnings about the potential effect on prices, though the US Federal Reserve (FED) has signalled it expects them to follow a steady trajectory in rate rising from 2023. In the UK, Bank of England Governor Andrew Bailey has said the bank was looking at ways to potentially tighten policy should a spike in spending increase inflationary pressures, but again this is not expected in 2021. Meanwhile European Central Bank (ECB) President Christine Lagarde said she expects price pressures to remain subdued overall, and that the ECB would “see through” any temporary inflation rise. Having said this, people parking container vessels across the SUEZ Canal certainly does not help short term inflation with oil prices spiking higher once again.
Despite the FED promising continued bond purchases and continuing with its promise of keeping rates low until 2023, they have stopped short from further interventions despite recent sharp upward movements in bond yields. The speed of the move is remarkable, considering ten-year US Treasury bond yields have risen from just over 0.9% at the start of the year, to around 1.7% following the meeting on Wednesday 17th March.
Investors have moved to price a faster pace of rate hikes given increasing inflation concerns. Rising real yields have driven investors to reassess their ‘growth’ equity weightings in light of fears that rates may rise faster than the FED has communicated, and for once the FED may actually be ‘behind the curve’! This trend has been emulated across developed markets.
While central banks continue to expect a strong rebound in growth this year (well above levels we have seen for decades), they do not see this as evidence of a change in longer-term price pressures. They view the base effects of oil prices and temporary tax cuts as one-off factors that will push inflation higher for only a short period of time. Globalisation and digitalisation as well as demographics are seen as structural influences on low inflation.
The so-called 'dot plot', which maps FED officials' views, showed the majority of FED members indicating that rates will remain unchanged until at least the end of 2023, although more members now see a chance for rate increases in 2023. The noteworthy change the FED adopted this week was to emphasise that their forward guidance was “outcome-based”. This is a significant shift, as the FED typically forecast the path of the economy and then adjusts monetary policy based on this. This new approach suggests they will wait for incoming economic and inflation data to see how the recovery evolves relative to their expectations.
The market nerves around inflation come down to a matter of timing. Governments and central banks want to support what might be a fragile recovery but given the difficulties of predicting the shape and nature of that recovery, fears of an overshoot in stimulus measures are inevitable. Unusual oil prices comparisons with last year only add to that sense of an impending shock. However, longer term structural trends, coupled with watchfulness from central banks, should serve to soften any post-virus spike in prices and we have used the last few weeks weakness in the markets to pick up some good quality investments at a good discount to the start of the year.