House Views - June 2021 - Expecting Near-Term Inflation

Macro
Vaccination programmes have accelerated across Europe since early April and governments have begun to follow the US and UK in easing lockdown restrictions in stages. The policy mix remains very supportive – we see no rate hikes on the horizon, asset purchases continue to supply ample liquidity and fiscal spending remains extremely generous. Our US macro cycle indicator is in recovery mode – which tends to provide a supportive backdrop to risky assets – and we expect a synchronised cyclical pickup in growth across advanced economies in the second half (H2). China has completed its recovery from the pandemic crisis after a period of double-digit growth in industrial production and retail sales, and the authorities have begun to scale back fiscal and monetary supports.

Central Banks
Inflation measures and expectations fell rapidly as the pandemic began to unfold last winter, given the high levels of uncertainty surrounding the impact of global lockdowns. One year later, the outlook is transformed – as we look forward to one of the quickest recoveries on record, inflation expectations have shifted markedly higher, driven by higher commodity prices and wages, rapid money-supply growth and skyrocketing fiscal spending. Nonetheless, we expect central banks to keep policy rather loose. They are convinced that the overshoot to their 2% inflation targets will prove temporary and there is still a long way to go before we reach full employment. Moreover, sizeable asset purchase programmes will be required to help finance the sovereign debt issuance required by fiscal spending plans.

Markets
The macro backdrop of cyclical recovery and surging inflation expectations paints a challenging backdrop for fixed income markets and we expect sovereign yields to continue to move higher. The difference in yields between corporate bonds and sovereigns (known as the “spread”) remains close to historical lows, offering little protection against rising yields. After a rapid rally since late March, we expect the euro to trade sideways against the US dollar for now. Our preferred asset class remains equities although global indices did recently reach all-time highs – valuations are rather pricy at present but earnings should grow strongly both this year and next, sentiment is rather buoyant but not at extremes, while upward momentum remains robust.

Bottom line
Fixed income markets should be kept Underweight in portfolios, in particular advanced economy sovereign bonds, although the yields available on emerging bonds – notably in China – remain attractive. We remain Overweight equity markets but have made some adjustments in regional allocations in order to favour more cyclically sensitive markets, such as the euro zone and the UK, over the US and emerging markets. This move also enhances exposure to the “Value” factor – stocks which rank as cheap on ratios such as price-to-book-value, dividend yield and price-to-earnings – while scaling back weightings in fast-expanding “Growth” sectors in portfolios. Gold has begun to recover from the recent sell-off and will be supported by falling real yields as rises in near-term inflation outstrip those in Treasury yields – we have moved back Overweight.

In accordance with the applicable regulation, we inform the reader that this material is qualified as a marketing document. CA25/H1/21
Unless otherwise specified, all figures in this report were taken from the following sources on 21/05/2021: Bloomberg and Datastream.

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