Equities have been range-bound as the year-end, and with it slower trading, approaches. The MSCI AC World index managed to return to its 8 December record level again on 15 December. The US S&P 500 index lost a slight 0.2% over the week since 8 December. European equities eased slightly over the same period, but rose solidly on 16 December.
In government bonds, the most notable movement was the fall in eurozone ‘peripheral’ yields after the announcements by the ECB on 10 December. The increase and extension of the pandemic emergency purchase programme (PEPP) and the ECB’s stated aim to ‘preserve favourable financing conditions' represent de facto informal yield and spread curve control.
Portuguese 10-year yields now seem well settled at below 0% and Spanish yields have joined them at the sub-zero level this week. The spread of Italian 10-year yields over Bunds has been falling towards 110bp. That is close to its lowest since early 2016.
The epidemic is not fading...
While everyone would like to have the year-end festivities on their mind, virus infection levels are becoming worrying again. The R reproduction rate has risen significantly, to above 1, in Germany and in more than half of the US states), or is approaching that critical level in Spain and in France. As a result, new restrictions have been put in place. In several countries, for example, the measures that entered into force on 14 December for five weeks are much stricter than they were in the first wave. Vaccination campaigns meanwhile have started in the UK and the US.
Some policy breakthroughs
On the economic relief front, there was some encouraging news. European leaders reached a compromise on the 2021-2027 budget that paved the way for the Next Generation EU stimulus plan. Poland and Hungary, worried about the mechanism linking access to European funds to respect for the rule of law, agreed to lift their veto.
This is an important step at a time when the resurgence of the coronavirus and the need to prolong or even amplify most public aid packages in 2021 make European budgetary solidarity more urgent.
Brexit and the damage a no-deal departure would do to the eurozone seem to be secondary to investors, judging by the relatively modest moves in Gilt yields and sterling. Investors still seem to be anticipating a last-ditch deal.
In the US, the Electoral College has endorsed Joe Biden's victory. Negotiations in Congress on further stimulus for the economy continue alongside those on extending the current budget to avoid a partial shutdown of the federal government. An ultimatum has been set for 18 December. The health crisis and Congress’s lame-duck status favour finding an agreement to fund the government.
Waiting for the US Federal Reserve
Investors' attention will shift temporarily from fiscal measures to the Fed's latest decisions. Few monetary policy changes are expected at today's rate-setting meeting. Growth and inflation forecasts for 2020 and 2021 might be lowered, but large-scale vaccinations should reduce the risk of another sharp downturn.
For many observers, the main question will be how many policymakers believe a rate rise would be appropriate in 2023. One market indicator, the overnight indexed swap, does not foreshadow any rise until mid-2024. Chair Jerome Powell face a tricky communication exercise. Under the new policy framework, he is expected to give more qualitative guidance on when the Fed will taper its asset purchases, lifting its foot off the brake that has been keeping rates low.
Deciphering economic indicators
Data from China remained encouraging in November: industrial production and retail sales were in line with expectations and continued to expand. Year-on-year, retail sales rose by 5%, signalling sustained economic growth with the epidemic under control.
In developed economies, purchasing manager indices were released earlier than usual. According to the flash estimate, eurozone PMIs exceeded expectations, including in the services sector where the index rose from 41.7 to 47.3.
Activity in the manufacturing sector accelerated: The index for Germany reached 58.6 – its highest in almost three years. In France, it rose back above 50 to 51.1, taking the composite index to 49.6, its highest in four months. As data collection stopped on 15 December, these indices do not take into account loosen the renewed restrictions that governments have been forced to impose ahead of the holidays.
Forecasters believe the effects on activity of the latest pandemic-stemming measures will be less strong than those in the spring. Companies have learned to adapt their production and sales processes, but consumer confidence may still suffer.
Our base case for 2021 assumes that investors will look beyond any temporary contraction in GDP growth, but financial markets are likely to remain choppy in the near term. It really is time for 2020 to end.
This is our last weekly investment update in 2020. We will resume this publication on 6 January 2021.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this article do not in any way constitute investment advice.