Economies took a hit last year since the Covid-19 pandemic even as central banks prop up liquidity through fiscal and monetary support. We digested a sizeable and targeted fiscal and monetary policy response and witnessed the market’s illiquidity and vulnerability. Stepping into 2Q2021, it is crucial to stay ahead and be equipped for a post-Covid world — The New Economic Cycle.
The global economy will recover more quickly and robustly from the Covid-19 recession than from a more typical large downturn. The backdrop for our optimistic outlook is the remarkable resilience we have seen despite the pandemic and the vaccine roll-outs that are going extremely well.
The S&P500 index continues to mark new all-time highs despite 10-year Treasury yields reaching 14-month highs as the market absorbed big spending plans. The recent rise in US Treasury yield reflects market sentiment for a trajectory in economic recovery fuelled by a very large fiscal stimulus package of US$1.9 trillion ($2.5 trillion) announced in early March and “once in a generation” US$2.25 trillion infrastructure plan unveiled recently by the Biden administration are boosting market confidence.
At the same time, the fact that the US Treasury is planning to borrow roughly four times the amount the Fed is lending could mean that external capital flows may be diverted from other markets in large amounts and is fuelling uncertainty and volatility in bond markets and other asset classes.
Looking over the horizon, 10-year US Treasury yields are expected to rise to 2.0% this year as the economy recovers and average 2.5% over the coming few years. We are still fundamentally optimistic on credit assets even with the 13% decline in long-duration US Treasuries in the 1Q2021 that has reduced valuation risk. The large US yield premium for long-term US Treasuries compared to other developed markets will attract global demand, likely slowing the rise in US yields. A plunge in foreign exchange hedging costs for US dollar assets is also a critical support in this asset.
We see near-term inflation to spike, with US Consumer Price Inflation (CPI) likely to rise above 3% annualised for the remainder of 2021. The Fed’s higher inflation target — to make up for the past decade’s shortfall in hitting that target — should benefit Treasury Inflation-Protected Securities (TIPS) over the long term. The heightened outlook for economic activity suggests the potential of inflation which impacted equities from end-February into the first week of March.
Question is, will we be expecting any rate hike in the near term? We continue to anticipate no rate hike this year in major economies like the US, Europe, United Kingdom, Australia and even Japan. Furthermore, we foresee a 6.0% to 8.0% US GDP growth in 2021 and 3.5% in 2022 with solid global economic growth, as well.
What’s more, the rise in bond yields is now forcing equity and credit investors to reassess. In the past six months, US “value” shares have outperformed large-cap growth shares by 14.5 percentage points as of March 21. Despite the recent rise in Treasury yields and a possible move higher, we believe that investors could benefit by holding a diversified set of fixed income alternatives within portfolios.
For many investors, especially in the US, municipal bonds continue to represent an attractive long-term core fixed-income holding. Likewise, sizeable value and opportunities emerged in US dollar emerging market debt and US bonds, especially fixed-to-floating rate bonds, bank loans, and TIPS. These fixed-income securities offer relative value compared to European and Japanese bonds.
Given large distortions to the world economy and record fiscal stimulus at a time of effective vaccinations, headline inflation in the coming year will likely exceed the long-term rate, it is important to keep in mind that long-term investing in a core portfolio creates the best investment results. Market timing can be damaging to long-term returns and strategic asset allocation is the first line of defence for long-term investors to an unanticipated shock.
Capitalise on market dislocations to invest in “unstoppable trends” that are multi-year phenomena and have the potential to transform the world. Investible themes we have identified include:
Greening the world
The switch from fossil fuels to renewables is integral to the process of “greening the world”. However, it is also only one facet of our transition to a more sustainable existence. This is as true for investors as it is for the whole of society. The emergence of a greener world has implications for the ways that we approach every investment.
Increasing longevity
As the demographic of the developed world continues to age, the rapid ageing of the world’s population presents many challenges for society, particularly related to healthcare. The Covid-19 pandemic further highlights the importance of healthcare need in personalised medication and treatment, healthcare infrastructure and pandemic preparedness, and remote monitoring and device.
Digitisation
The world is in the midst of a digital revolution that is about to enter a new phase. Over decades, digitally disruptive innovations have brought about a transformation of how we live and work. The full-scale roll-out of 5G wireless data networks and new wireless technologies will enable a large increase in connected devices, with a vast acceleration in data produced.
The rise of Asia
With Asia’s importance in the world economy rising, we expect continued strategic competition between the US and China. Both developments offer compelling potential investment opportunities. There are a vast number of opportunities linked to the emergence of separate technological standards, the acceleration of middle-class consumption in Asia and supply chain diversification away from China.
Leo Boon Yin is head of investment and treasury products, Citibank Singapore
