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August 2021 Monthly Market Commentary: Post-Covid recovery largely on track despite regulatory and political headwinds

14 September 2021

MARKET CONTEXT: Post-Covid recovery largely on track despite regulatory and political headwinds

Global Macro:  The proportion of vaccinated people continues to rise around the world while the number of deaths is decreasing rapidly despite the Delta variant. The global economy is normalizing with key unemployment figures improving, albeit not yet at pre-pandemic levels. Expected growth for 2021 remains strong, led by China (+8.5%; vs US +6.5%, Europe +5.1%, Asia +7.1%). We also note corporate earnings have beaten expectations in major economies. As anticipated, inflation appears to be transitory, with China’s annual inflation rate at 0.8% in August, below market consensus (1.0%), thus easing the pressure on central banks to hike their short-term rates. As such, we expect short-term interest rates to remain near zero in the West and close to 2.20% in China. Nonetheless, with inflation twice as high as pre-Covid levels and a solid global economic recovery, we believe central banks in major economic blocs will start reducing their bond purchasing programs within the next 12 months, thus allowing long-term rates to increase. However, we think the rise will be moderate as governments in the US and Europe have seen their budget deficit skyrocket following the roll-out of costly stimulus measures to keep their economy on track during the pandemic and thus cannot afford to let long-term rates rise too much as it would increase the cost of servicing their debt.

Financial Markets: 

Based on our econometric model, over the next 12 months, we expect to see the 10-year US Treasury yield within the [1.2%; 2.0%] range, the 10-year German Bund yield within [-0.4%; +0.2%], and the 10-year Chinese government bond yield within [2.8%; 3.2%]. On one hand, the Fed and ECB are trying to find a way to taper their bond buying programs without scaring the market; on the other hand, many large pension funds would place buying orders if the 10-year US Treasury yield approached 2% and the Bund yield became positive, which would lower the upside pressure on long-term interest rates. On the equity side, we expect the environment to remain favorable for global stock markets until the end of the year as central banks maintain their accommodative monetary policy and earnings continue to rise. We are positive on Chinese equities as a large risk premium is already priced in to reflect the country’s increased regulatory oversight in sectors within the digital transformation space. The government’s policy is pro-growth, banks’ reserve requirement ratio (RRR) is expected to be eased, and local government bond issuances are planned to increase substantially by year end. Overall, the Chinese economy is expected to be the fastest growing among major economies, both in 2021 (+8.5%) and 2022 (+6.5%). On the currency side, despite the Chinese equity sell-off this summer, USDRMB was unable to appreciate and stay above the 6.50 resistance level. Based on our econometric model, we believe the US dollar will continue its secular bearish trend, on the back of the US twin deficit and global de-dollarization trend, while expecting the renminbi to be supported by China’s strong economic growth. We expect EURUSD to remain relatively stable within the [1.16; 1.24] range.

Equity: Month to date the S&P 500, Euro Stoxx 50, and Nikkei 225 gained 3.0%, 2.6%, and 3.0%, respectively, against a positive backdrop for global equities; by contrast, the Hang Seng Index edged down 0.3% as investors remained prudent following China’s recent regulatory tightening. Fixed Income: The 10-year US yield rose 6bps in August to 1.30%, while Emerging Market government bonds (+0.7% in USD; +0.6% in local currencies) and High-yield corporate bonds (+0.5% in USD; +0.2% in EUR) all increased. Currencies: The greenback appreciated against other major currencies amid market expectations of tightening measures from the Fed: EUR -0.8%, AUD -1.4%, CNY -0.2%; safe-haven JPY -0.5%, CHF -1.3%. Commodities: After an initial sell-off in early August, gold recovered and ended the month flattish (+0.1%); oil prices fell 7.4% due to concerns over a slower demand recovery as the Delta variant progressed.