Our Global Head of Desk Strategy John Briggs reflects on how some of the major calls from our Year Ahead 2021 outlook are evolving – and their impact on economies & markets in the months to come.
The first quarter of 2021 has been eventful to say the least: from the realities of Brexit setting in, a new US administration, lockdown woes exacerbated by varying degrees of global vaccine hiccups, a reflation rout in bonds and myriad central bank responses, to idiosyncratic volatility in emerging markets (EM), discussion of a new commodity super cycle, a strong rally in cryptocurrencies and the rise of the “meme” stocks.
With so much change afoot, it’s useful to check in on our core Year Ahead 2021 calls from November last year to see which themes are still applicable or likely to continue driving markets, and which may have run their course.
Last November, we wrote: “The return of fiscal policy as the main lever for policymaking is what will matter most for markets in the coming years.” Fiscal policy is not only here to stay – we’ve seen a doubling-down of government support for economies in recent months. In the US, the most recent $1.9 trillion fiscal package means support in 2021 remains as expansive as in 2020 and may grow as multi-year support looms. Though UK fiscal support in 2021 is lower than that seen the previous year, as shown in the chart below, it’s difficult to describe stimulus worth 9% of gross domestic product (GDP) as anything less than significantly accommodative.
Fiscal policy stimulus remains generous (% of GDP)
Sources: US Office of Management and Budget (OMB), Eurostat, UK Office for Budget Responsibility (OBR)
Due largely to this incredible fiscal support, the potential consumer firepower that can be deployed as economies reopen is massive. Consumers have stockpiled incredibly high savings compared with pre-pandemic levels, some of it “forced” due to government transfers. In any case, NatWest forecasts above consensus growth this year across all the major economies (more on this in our latest quarterly outlook).
Following from our belief that 2021 (and beyond) would see the dramatic and enduring rise of fiscal policy was the view that increased government bond supply and rising concerns about future inflation would weigh on long-term bond yields in the US, UK, and Europe. To be fair, we saw the rise in yields as more of a process throughout the year, and we did not expect nearly our entire forecast yield rises to take place in Q1.
Indeed, most global sovereign bond yields are near our updated end-of-year forecasts, so while we are still negative, we have scaled back our bearishness on government bonds. The one bond market that has not seen yields rise as much as expected is Europe, where sluggish vaccine progress and new waves of infections have delayed reopening (more on this below). Still, even after the rise in yields seen in Q1, we do think the path of least resistance is higher still. We also believe disruptive yield volatility is behind us – for now.
Bond yields edge higher on rising inflation expectations (%)
Sources: Bloomberg, NatWest Markets
Much of the rise in long-term bond yields is owed to concerns over inflation. In November 2020, we noted “medium-run risks are tilted sharply higher and markets are too pessimistic.” As shown in the chart below, it is hard to describe the market’s inflation expectations as pessimistic anymore. Given the size of the move higher in just one quarter, further gains may be difficult until we see actual proof inflation is rising, but nevertheless we expect market inflation expectations to remain anchored at or near these levels well into the recovery.
Markets expect inflation to lift higher (%)
Sources: Bloomberg, NatWest Markets
Vaccine progress and declining case numbers means the light at the end of the tunnel can be seen in many parts of world, but some nations have succeeded more than others on both fronts. In the Year Ahead 2021, we introduced our COVID Framework, where we scored each nation based on a variety of factors related to management of the pandemic.
We updated this framework in March to account for increased vaccinations as well as economic growth momentum for those exposed to a more service-based economy, which has clearly borne the brunt of the pain – and is therefore likely to see the greatest rebound as economies open up (click here for a deeper dive).
One area we focused on was score momentum, which is arguably as (if not more) important as a static snapshot of current progress. The chart below shows how a selection of countries has performed since November 2020 when taking these additional factors into account. The US and UK clearly stand out amongst Western nations as much improved. As too does much of Asia, though others in the region have fallen behind.
COVID as a growth differentiator: change from November 2020 to 24 March 2021
Sources: International Monetary Fund (IMF), Haver, Bloomberg, NatWest Markets, OurWorldInData.org. Positive scores suggest vaccination progress & pandemic management will positively affect economic growth, and negative scores imply the opposite.
Notably, most core European countries (outside of Italy) do not score well, perhaps unsurprising given their vaccine challenges in 2021. Asset performance has so far lined up with this score momentum: bond yields in the US and UK led the way higher; equity markets in both countries have proven resilient, and Sterling has been an outperformer.
Which countries will see the greatest improvements in Q2 and thus possibly see their assets outperform? Austria, Canada, and a number of emerging market countries have shown strong progress of late.
This takes us to one Year Ahead theme that did not play out for us: that growth momentum would shift from Europe to the US early in the year. Several important factors play into this. US fiscal stimulus was greater in 2021 than expected. European vaccine progress was much slower than expected – and lockdowns in response to rising cases was larger than expected. By comparison, the US did not see widespread strict lockdowns, and the UK was able to outperform against expectations.
We do still see strong growth for Europe this year. But vaccine issues and reopening delays reinforce our bearish view of German government bonds (bunds), especially in light of increased purchases by the European Central Bank (ECB) aimed at taming a disruptive rise in yields. So, we came into the year bearish 10-year bunds, and yields did rise – though not as much as their peers. We remain positive on European inflation, and in time, as the growth momentum shifts later this year, may get more bullish on the Euro.
In our Year Ahead report, we said: “While momentum has been building around sustainable finance for some time, we think 2021 will mark an inflexion point.” This certainly appears to be the case. In the first quarter of 2021, we have seen nearly half the issuance of green, social, sustainable and sustainability-linked (GSSS) bonds that we saw in all of 2020.
Global GSSS supply in 2021: first quarter volumes equate to half of all 2020 issuance
Global GSSS supply in 2021: sovereign issuance nearing full-year 2020 levels
In addition to increased supply, larger GSSS bond price premiums have been notable. Recent bond issues from France and Italy offer substantial premiums to their normal (i.e. vanilla bond) sovereign bond curves (7.5 basis points and 11.2 basis points respectively), mirroring a broader market trend (see chart below).
A ‘greenium’ – the price premium on green bonds – can be seen across all European sovereigns (basis points)
Sources: NatWest Markets
With COP26 scheduled to be held later this year, and substantial progress expected on regulatory and taxonomy issues, 2021 does appear to be an inflection point for the mainstreaming of ESG* investing, issuance, and government policy.
*ESG stands for environment, social & governance. Click here to visit our ESG Hub for news, views & analysis related to sustainable finance.
Finally, a post-Brexit trade deal – the EU-UK Trade and Cooperation Agreement (TCA) – was concluded by the EU & UK on Christmas Eve, as expected. But, as with many Christmas presents, the contents risk disappointing its recipients. In essence, the EU-UK TCA secured tariff-free trade on (qualifying) goods, but little for services. There was no equivalence settlement for financial services, let alone a chapter on financial services. However, both the UK & EU recently redoubled efforts to coordinate on financial regulation & access arrangements.
Against that backdrop, the future for UK-EU trade for both in goods and services looks less certain. Near-term frictions in goods trade are increasingly apparent with rules of origin requirements piling on costs & administrative burdens for corporates and disrupting supply chains (to find out how we’re supporting businesses post-Brexit, click here). The need to prepare and review supply chains is significant.
Meanwhile, the Northern Ireland border issue is proving challenging. UK exports to the EU slumped by 40% in January, disproportionately affecting smaller UK firms. The January hit to trade exaggerates the longer-term effects of Brexit, but we continue to expect the UK’s exit from the single market to weigh on productivity and growth over the medium-term, lowering annual GDP growth by roughly 0.25 – 0.5%.