Economics and Strategy
Global GDP Forecasts Revised Higher While Rate Moves Benefit Cyclicals and Risk Parity
Jefferies Chief Financial Economist Aneta Markowska expects U.S. growth to average nearly 7% this year, with an even stronger first half. She expects the trio of explosive fiscal support, unprecedented pent-up demand and pent-up savings to produce a sharp increase in consumer spending post-vaccine. The combo of strong demand and record-low inventories will in turn propel manufacturing activity higher, which should push capacity utilization well above pre-pandemic levels by mid-year, unleashing a full-blown industrial capex cycle and a self-sustaining recovery. Stronger growth will lead to more inflationary pressures in the medium-term and even more Fed tightening than is currently priced in. Aneta expects the 10 year Treasury to rise to 2% by year-end and expects the recovery to remain intact in the face of higher rates which are rising “for the right reasons.”
Similarly, Chief European Financial Economist David Owen sees signs that the UK economy will start to outperform from Q2 onward. In addition to the effects of the pre-announced 2023 rise in the corporate tax rate to 25%, David expects the two-year window for a 130% super deduction for investment in plant and machinery to bring spending forward, prompting him to increase his 2022 GDP forecast for the UK to 7.6% following the 4.4% in 2021. Meanwhile, with the rate of vaccine roll-out in the Euro area lagging the U.S. and UK, at its latest meeting the ECB delivered an aggressive response to the recent rise in bond yields and committed to a significant step-up in its weekly QE purchases. In its latest forecasts, the ECB expects the Euro area economy to grow by about 1.5% Q/Q in Q2 and Q3. But the outlook is highly uncertain, and there is a clear determination that financing conditions remain extremely accommodative in the early stages of the recovery.
For Chief Market Strategist David Zervos the backdrop remains conducive to his “Spoos & J’s” trade (i.e., long S&Ps hedged with Jerome Powell and Janet Yellen) despite recent volatility. He points out that in the face of fiscal stimulus-derived fears, the only true policy driver affecting broad economic and financial market outcomes, and therefore inflation, comes via the monetary channel. He expects that supply-side secular forces will remain in play to control inflation with the Fed likely to struggle to achieve their sustained 2% inflation overshoot. In addition, he believes the current market dynamics are evidence of “the handoff,” the point at which monetary policy takes a back seat to private-sector animal spirits and the constant Fed support is replaced with true, organic economic growth. Additionally, David sees one benefit of yields backing up to 2% is the potential to reawaken the risk parity trade.
Global and Asia Equity Strategist Christopher Wood’s base case remains that cyclical stocks will continue to rally and Treasury bonds will sell off more before the risk of a potential tapering scare increases. This could occur if the market starts to worry that the Fed may taper earlier than the current expectation of a gradual tapering in early 2022 and continuing through the year before interest rate “lift off” in 2023. If inflation expectations rise above 2.5%, it will become harder for the Fed to ignore, as in the market will focus on the degree of overshoot tolerated by the American central bank. Meanwhile, the back up in 10-year Treasury bond yields has the potential to revive the risk parity trade in the U.S., assuming the deflationary trend resumes and the Fed turns orthodox by not introducing a regime of formal repression by locking in bond yields.
Global Equity Strategist Sean Darby remains bullish on the more cyclical sectors like industrials, materials, financials and energy. He believes the stars are aligned for global equities as the vaccine roll-out unleashes pent-up demand coinciding with improving global trade and rising manufacturing. To date, Sean believes the sell-off in bond yields has not hampered share prices since inflation prospects are brightening while earnings continue to be revised up.