COVID-19 – Herd immunity in sight?
New Covid-19 cases around the world have risen and now stand at 390 000 a day. Rises in Europe, Asia, and Africa are offsetting a decline in South America. The UK accounts for more than a third of daily new cases in Europe; the spread of the Delta variant among younger age groups with no or just one dose of the vaccine has fuelled the surge.
Evidence points to vaccines limiting the severity of symptoms; so far, the rise in new cases in the UK has not led to a material rise in hospitalisations.
Based on the current pace of vaccinations, the majority of countries across Europe are expected to reach a level of vaccine coverage consistent with herd immunity by the end of September.
Update on thinking at the US Federal Reserve
The minutes of June’s FOMC meeting can be expected to highlight details of the start of the policy-setting committee‘s discussion on tapering the central bank’s asset purchases. It should also provide insights into participant views on the economic outlook that drove a hawkish shift in the interest-rate projections of committee members.
The market will be looking for any further indications as to Fed Chair Jay Powell’s comments that tapering was at the forefront of the committee’s discussions last month.
Although Powell has reiterated that tapering itself was not yet imminent and has promised advance notice, he has also stated that the Fed would begin reviewing the progress of the economic recovery on a meeting-by-meeting basis.
The next FOMC meeting is on 27-28 July.
The shape of the US jobs market
US non-farm payrolls rose by 850 000 in June, beating consensus expectations. The details of the report were less positive, and indicative of a constrained labour supply. This was also highlighted in the latest ISM services number.
The rise in non-farm jobs was driven in large part by state & local education hiring. This rose by a whopping 230 000. Private sector payrolls rose by a more measured 662 000, again led by reopening-oriented sectors such as leisure & hospitality and retail trade.
Supply should continue to loosen as we move further into the year. Theoretically, we believe the Fed is on track for a detailed discussion on tapering at its July meeting followed by formal communication in September, an announcement in December, and implementation in January.
Meanwhile in the eurozone
European purchasing managers indices (PMIs) for June have confirmed that activity across the eurozone and UK is taking off, supporting expectations of strong GDP growth over the summer months. Improvements in services PMIs are reflecting the reopening of the sector, which is being facilitated by effective vaccination rollouts across Europe.
Encouragingly, manufacturing output has remained resilient at high levels despite reports of persistent supply chain disruptions. The overall picture is of a eurozone economy running hot, with demand recovering rapidly and supply still constricted. All of this is increasing inflationary pressures, which could be more enduring than generally assumed.
ECB strategy review
The European Central Bank will continue to meet this week to discuss the strategy review. The aim of the meeting is to agree on the review, with the possibility of an official announcement, should there be an accord. If there is a communiqué, it is expected to be relatively high level at this stage.
An agreement this week would increase the chances of an earlier change in the forward guidance – as soon as the 22 July governing council meeting. Any change is likely to consolidate a lasting shift at the ECB towards prolonged monetary accommodation. In particular, the central bank may acknowledge a willingness to overshoot on inflation.
Interest rates fall further
Since the start of June, the US yield curve has flattened (i.e. the gap between yields on the longest and shortest-dated bonds has shrunk), while bond yields themselves have fallen significantly. That directly implies a market expectation of lower inflation and an economy that is not so strong that higher policy rates are required to rein it in.
US real yields (adjusted for inflation) are arguably the single best indicator of the state of financial conditions. They are now back to almost exactly -1%, based on 10-year Treasuries. This was a level never seen before the second half of 2020. The sharp rise in real yields that occurred last February has now been retraced almost totally.
This week, the yield on the benchmark 10-year Treasury bond has fallen by 0.02% to 1.35%, marking a four-month low. Germany’s equivalent Bund yield dropped by the same amount to minus 0.28 %, its lowest since mid-April.
Back in March, the 10-year Treasury yield had approached 1.8 % as the price of the debt was depressed by fears that the Fed would respond to a speedy US economic recovery and rising inflation with a series of interest-rate increases.
These fears now appear to have been side-lined. In part, this may be due to an anticipation that US GDP growth, which is expected to have reached an annualised rate of at least 9 % in the second quarter, is about to peak and a slowdown phase of the economic cycle is around the corner.
Some of the worries over inflation may also have been soothed by President Joe Biden cutting the cost of his proposed infrastructure stimulus spending package by more than half to USD 1 trillion.
July tends to be a seasonally bullish period for risky assets and a time when market volatility across asset classes trends lower. Given that it is unlikely that we will see any major central bank surprises between now and the Fed’s annual Jackson Hole policy symposium (to be held in-person this year) on 26-28 August, interest-rate volatility should also trend lower over the short term.
While markets may be somewhat overbought with positioning, especially in US equities, at cyclical highs, current economic and market conditions still create a constructive backdrop for markets and a risk-on stance over the summer. Given the cheaper valuations, we believe European equities offer potential for attractive upside.
In credit markets, the fundamentals have continued to improve, but valuations currently look on the rich side, especially in investment-grade credit. In our view, high-yield and leveraged loans look more attractive in a rising yield world, given their higher income and shorter duration.
From a seasonal perspective, however, credit markets should outperform in July.
We believe the outlook remains constructive for risky assets as they should do well in an environment where economies are reopening, growth is rebounding, and policymakers remain accommodative.
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 podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.