Newsletter
Rob Hayward
January 2021
Economic conditions
The world economy is gradually emerging from the shock of the Corona virus. Economic activity in China has stated to accelerate. This will affect other parts of the world. Expectations about rising economic growth have resulted in higher prices for developed (SPY) and emerging economy equities (EEM) and a rotation away from government debt (TLT). The resultant rise in bond yields may provide some constraint on economic recovery in the rest of 2021. A lot of good news is priced in. The evolution of the virus, the vaccine and immunity will be watched with interest.
Economic growth in a number of emerging economics such as India, Mexico and South Africa has been lower than had been anticipated. However, there are signs that economies are gradually responding to fiscal and monetary stimulus. The rate of growth of international trade has been disappointing. The continued US-Chinese trade dispute and the effect of extreme climate conditions in Africa and elsewhere are factors clouding forecasts moving forward.
Projections
| Indicator | 2020 | 2021 | 2022 | 2023 |
|---|---|---|---|---|
| World growth | 0.0 | 3.5 | 5.0 | 4.5 |
| US GDP | -2.4 | 5.5 | 5.0 | 4.0 |
| US Inflation | 1.2 | 2.5 | 3.0 | 3.0 |
| US Unemployment | 7.0 | 6.0 | 5.0 | 4.0 |
| US bond yield | 1.0 | 2.0 | 2.5 | 2.5 |
Upcoming events
US interest rate outlook: the central bank projects stable interest rates in the coming year. However, There is a large amount of uncertainty and there are a large number of investors who believe either that additional monetary stimulus will be necessary to support the economy and that interest rates will remain lower for longer, or that inflationary pressure will require higher interest rates before the end of the year. There is scope for a surprise. Much depends on the ability of new President Biden to push fiscal measures through Congress.
US Fiscal Policy US President Biden is pushing a substantial fiscal package through Congress. Despite the slim Democrat majority in each house, some concessions are likely to be needed to secure passage of the bill. The less the spending pledges, minimum wage increases and unemployment benefits are watered-down, the more positive for the economy and the more negative for monetary policy and inflation. Large concessions and lengthy delay will be negative for the economy and may provide some support for bonds.
Assets
Stocks US and (to a lesser extent) other international stocks are already pricing in economic recovery. The price of US equities relative to the earnings that have been achieved are high. Substantial improvement in earning will be necessary to maintain current levels.
Bonds The 10-year government yield has moved through the 1.0% level and is project to continue higher. Low interest rates and bond purchases as part of the Fed’s quantitative easing program are providing support. Bonds will fluctuate inversely to the outlook for the economy. The big risk is a pick up in inflation that would complicate central bank policy and raise questions about the low level of real yields.
Gold (GLD) is drifting lower with an easing of the virus and a change in the Presidency. However, expectations for continued US dollar printing as part of the quantitative easing process have raised some doubts about the position of the US unit as a dependable reserve currency. Gold would benefit from these doubts and any rise in inflation.
Credit spreads are stable having been prevented from widening by the aggressive action from the US Federal Reserve at the start of the lockdown. While widening in the spread between government and corporate bonds should be limited by a robust economic expansion, debt is highest in those parts of the economy that will continue to suffer from the post-Covid adjustments that will have to be made. Some spread slippage appears to be inevitable as reality bites.