The new year has begun with winter virus waves challenging the favourable outlook for risk assets. Governments in the UK, Eurozone and Japan are considering tightening restrictions on activity and extending lockdowns throughout January. Vaccine distribution has begun only slowly in the US and France. Thus, economic growth is likely to be weak across the major economies over Q4’20 and Q1’21 with the notable exception of China.
High frequency data and leading economic indicators will be important to assess the near-term impact of the latest virus waves.
The chart above of the New York Federal Reserve’s Weekly Economic Index shows activity in the US so far continues to recover from the worst of the pandemic in early 2020. But GDP still appears to be over 1% weaker than a year ago.
The second chart shows purchasing manager indices (PMI) have fallen recently in the major economies owing to the pandemic’s resurgence but business confidence remains far more robust compared to during the first virus waves last year. Even if near term economic data falters sharply, we expect financial markets will still be supported by the longer-term positive outlook for 2021.
First, global growth is likely to rebound strongly as vaccines enable economic activity to recover. We forecast the world economy to expand by 5.6% in 2021 after a likely contraction of -4.1% in 2020 with China’s economy growing by 8.1%, the Eurozone by 5.5% and the US by 5.0% this year.
Second, inflation will pick up as the pandemic eases and activity rebounds. But consumer price rises are likely to stay anchored around central banks’ 2% targets. This will allow the Federal Reserve and its peers to keep interest rates at near zero levels for up to four more years.
Third, governments are likely to keep running major budget deficits. At the end of December, Congress passed a new round of emergency aid worth USD900 billion or 4% of US GDP. This will top up unemployment benefits and give households new stimulus cheques until the end of Q1’21.
Last, risk assets are also set to benefit from bond yields staying very low and the USD continuing to fall. We forecast 10Y Treasury yields will only rise to 1.20% over 2021 while the EUR and CNY may rally to 1.25 and 6.30 against the safe-haven USD.
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Version: July 2020