MACRO
The downshift in growth momentum since midyear will show in the upcoming 3Q21 GDP reports. China kicked off with a material disappointment as power shortages and soaring
commodity prices weighted on manufacturing, while strict Covid controls put a brake on holiday spending. The US should slow to 3% growing to a surprising contraction in domestic final sales. The Euro area should still expand above 8%, leaving global GDP growth expanding at an above-potential 3.4% pace for 3Q21. However, this outcome would represent a substantial step back in the speed of the recovery, still leaving global GDP 2.7% below pre-pandemic level.
Consumer price inflation has risen globally, fueling concerns of an overheated economy boosted by an exceptionally expansionary monetary and fiscal policy mix, particularly in the US. In the Eurozone and Japan, inflation is unlikely to become a constraint for loose monetary policy any time soon. The recent increase in global inflation is largely due to higher oil prices. WTI crude rose over 10% this month. However, OPEC+ experts determined that the global oil- supply deficit will be just 300,000 barrels a day on average in 4Q21, much smaller than the 1.1-million-barrel daily shortfall shown in figures initially presented. Goods demand should normalize, thus reducing the upward pressure on prices. While recovering, services demand is lagging. Employment is recovering, but wages are not rising at a faster pace-although some low paying jobs have seen substantial raises. The Fed and ECB have revised their inflation target, while still adhering to an accommodative monetary policy. The concept of “transitory” inflation now seems closely linked to oil and supply lines and their normalization.
After a period of a very benign rate outlook, developed markets’ yield curves have started to price a more serious response from central banks, along with the surge in inflation expectations. The market now anticipates at least two Fed rate hikes in ’22. This has led to a substantial flattening of the yield curve, with the US 2year Treasury yield jumping from 0.3 to 0.5%, while the ten year barely changed. Markets are anticipating a move that may not materialize: high oil prices act like a tax and the low yield on the longer end signals slower growth. Bond tapering should start very soon but independently of rate hikes.
MARKETS
October saw strong total returns across major equity regions, with the US outperforming others (+7.0%). Japan was the only major region with negative total returns (- 1.4%). Consumer discretionary was the best performing global equity sector (+8.0%), followed by Energy. The US earnings season has generally surprised to the upside so far, with cyclical and energy companies among major contributors to positive earnings revisions. However, third-quarter reporting has proven weaker in Europe. Companies continue to reference supply and rising costs as their two foremost challenges. The ability to compensate for rising costs will be a key differentiator in performances across companies.
DM rates and credit saw negative returns, particularly in the short maturities. Emerging markets suffered the most as spreads widened.
PORTFOLIO
In equities, we added financials. In credit, we rotated partially into shorter HY and inflation linked bonds.
OUTLOOK
4Q21 GDP growth should resume, supporting equities. With inflation looking more stubborn than previously thought, investors are fretting about central banks’ next moves. Despite the combination of supply-chain disruptions, high oil prices and labor shortages that complicate central bank actions, the current trend is for developed market base rates to move higher. In credit, we expect upgrades in HY bonds, driven by Energy, Auto, Healthcare and Utilities as economic strength continues and more quarters of stronger credit metrics are reported. We therefore maintain our overweight in HY with short maturities.