Last innings of the reopening trade

9 July 2021

Global overview

Big picture

It’s time to think beyond the reopening and examine factors that could drive the post-COVID-19 global economy. While many countries have only just embarked on the path toward reopening, the world’s largest economies—the United States and China—are already well on their way, with Europe and Canada following closely behind as vaccination rollouts accelerate in those countries. Indeed, the road map to reopening has been laid out, and uncertainties surrounding the virus, vaccination, and how economies might fare as they reopen have diminished substantially. Now that the global macro environment is in the last innings of the reopen/ reflation narrative, what comes next?

All things considered, there are important factors that remain supportive of risk assets: Global growth is likely to be running at historically high levels throughout 2021 (and into 2022), and monetary and fiscal policy will continue to be extraordinarily accommodative. In absolute terms, most global macro indicators appear very strong; however, we believe these supportive factors will begin to diminish on a relative basis going forward, implying that we’re currently at peak macro—and the road ahead could be bumpy.

In our view, the somewhat more challenging macro environment should be able to mitigate the gradual rise in market rates, and we expect it to be less damaging to equities. Crucially, we believe sector selection, country selection, and regional focus will play a very important role in asset allocation decisions in the coming months—the ability to distinguish which elements in the macro narrative have reached peak (versus those that haven’t) could be critical to outcomes in the third and fourth quarters of 2021.

Peak macro factors

Peak monetary policy accommodation

Global central banks have directly or indirectly indicated that they’re taking their foot off the easing pedal. Yes, monetary policy remains extremely accommodative, which is broadly supportive for risk, but U.S. Federal Reserve (Fed) Chair Jerome Powell has hinted that the time to taper the central bank’s asset purchasing program is approaching,1 the Bank of Canada (BoC) began tapering in April,2 the Bank of England (BoE) has firmed up its rate forecast3 and its quantitative easing (QE) is scheduled to be done by year end, and the European Central Bank (ECB) has upgraded the balance of risks to growth from tilting to the downside to neutral.4 Even the Bank of Japan (BoJ) continues to entertain the prospect of widening the 10-year yield’s target band, while the People’s Bank of China (PBoC) has begun tightening monetary conditions. It’s fair to say that their plans have already been well telegraphed; however, monetary accommodation has reached an inflection point—and we’ve entered a period in which communication errors (and potential policy errors) are no longer unthinkable.

Peak U.S. fiscal policy support

Fiscal spending in the United States and globally is likely to stay elevated (which explains why the five-year inflation outlook in a post-COVID-19 world is higher than before COVID-19); however, we expect the fiscal impulse is going to wane significantly in the next two years. Should this happen, it’ll translate—mathematically—into a sizable drag on growth in 2022. In our view, this should be understood as a fiscal cliff. In fact, when the expected reduction in fiscal spending is expressed as a percentage share of the expected resultant fall in fiscal deficit, it’s likely to be the largest fiscal cliff since the 1940s. Unsurprisingly, this has fueled speculation that the current growth cycle will be a very short one. While we expect a sizable drop in U.S. growth in late 2022, we certainly don’t expect a recession to materialize.

Peak reflation

We’ve discussed inflation at length in the last quarter, and our view remains that inflation is likely to stay elevated throughout Q3 before easing back to around 2.0% in 2022, followed by structurally higher inflation—possibly closer to the 2.5% mark— in 2023 and beyond. In that sense, the phrase peak reflation—as it’s used here—is less a comment on direct measured inflation (although that most likely did peak in May 2021) and more a reflection of our expectation that market-based measures of inflation, such as breakevens and consumer confidence expectations, have peaked. Problematically, we expect the reflation narrative to move from being framed as a positive development to being seen as a warning about higher input costs across a select set of industries that have been beset by supply chain disruptions. In other words, certain areas may continue to face margin squeezes while others experience relief, thereby increasing the value of solid active management in the equities space. Importantly, there’s little central banks can do to mitigate the situation.

Peak China impulse

The Chinese economy was first to enter into a COVID-19 recession and the first to emerge out of it. China is also the first country to materially tighten fiscal and monetary support through a range of measures—including the introduction of new regulations to dampen speculation in the property sector. As a result, China’s credit impulse has decelerated, a development— as we’ve learned from past experience—that could hurt global trade and global industrial production.

Peak aggregate U.S. data

To be clear, our view on the U.S. economy hasn’t changed: We still expect growth to remain robust throughout 2021, and into 2022 thanks to fiscal stimulus (which remains high in absolute terms), pent-up consumer demand, and high levels of savings. However, it’s important to note that much of these positive factors have already been priced in and there are a few key sectors that could begin to decelerate this summer (i.e., slipping to levels that should still be considered as healthy when viewed from a historical context). These include housing activity, retail sales, and industrial activity. Indeed, we see more downside risks than upside risks on this front and, therefore, scope for disappointment.

Factors not yet at peak

While several key growth drivers have peaked, there are others that have yet to do so.

Europe and Canada

The eurozone and Canada have significantly lagged the U.S. reopening due partly to a slower vaccine rollout—the pace has since picked up but market expectations have yet to catch up— which we believe could create opportunities. Crucially, there’s still room for these two economies’ macro narrative to surprise to the upside, especially in Europe, where the ECB remains the most accommodative of all global central banks.

Global labor markets

Employment rates—and associated data—have always been lagging indicators, but in this case, we believe there’s substantial progress to be made. In our view, September could see the return of labor supply, as various government support programs come to an end (in the U.S. and in Canada), concerns about COVID-19 diminish as inoculation rates rise, and in-person schooling resumes. Barring surprises, these developments could keep wage pressures at bay.

Global capital expenditure

Capital investment is critical to global growth, and we believe this is one area that has the potential to provide the positive surprise needed to offset peak fiscal policy (and monetary policy). Our leading indicators suggest capex is the pillar of the next phase of global growth and will likely mollify concerns relating to the duration of the current growth cycle.

Select emerging markets

While we remain cautious on the broad emerging-market (EM) universe, we believe several markets could surprise to the upside, including Brazil, South Korea, Indonesia, and India.

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1 “Fed’s Taper Timing Moves Into Focus After Dot-Plot Surprise,” Bloomberg, June 18, 2021.
2 Bank of Canada, April 21, 2021.
3 Bank of England, May 6, 2021.
4 European Central Bank, June 2021.