Will the Brighter New Year Stay in Sync?
As we all bid good riddance to 2020—its pandemic, its politics and its market volatility—the picture coming into view looks brighter. The arrival of vaccines sooner and more effective than expected remains December’s top headline and offers the prospect of a faster and broader return to normal activities. The approval of a new U.S. stimulus package provides an unexpected bonus. Markets have certainly priced in a sharp, dramatic and apparently synchronized recovery. Extended winter lockdowns in Europe and the United States could tip the fourth quarter into a second dip, but brighter days clearly lie ahead.
Yet, we wonder just how sharp and synchronized a global economy we can expect. Asia continues to power ahead, but the recovery may not deliver as many jobs in Europe amid post-crisis corporate restructuring, and the U.S. fiscal debate may soon turn to deficit reduction. Given lingering damage from the pandemic, continuing risks to vaccine rollout and likely divergences in government policy, we stay with our central scenario that 2021 will deliver what we call “Not Quite Recovery.”
In the near term, this should still be supportive of risk assets—equities, credit and emerging markets. European government bonds may continue to perform, but U.S. Treasuries may suffer as yields drift above 1%. As valuations begin to look even more stretched, however, in the spring markets may face periods of volatility and uncertainty as the unclear leg of the cycle comes into view. With brighter prospects for the spring and summer, we also raise the odds for our more bullish “Escape Velocity” scenario to 20%, acknowledging the possibility that scars may turn out to be less deep than we currently expect. With a U.S. stimulus package in the books and a clear European commitment to its recovery fund, we reduce the odds for our “Fiscal Cliff” outcome to 10%.
After what will be a difficult winter with COVID-19 cases and deaths still rising, the summer looks dramatically better with a burst of pent-up demand for plane tickets and restaurant meals. But the lasting damage is real: recent jobless claims have stabilized below a million per week, and rising numbers of long-term unemployed will not automatically find work again. Bankruptcies remain low compared to previous crises but are edging higher.
While the Federal Reserve continues to signal readiness to extend monetary accommodation as long as necessary, the fiscal picture is much cloudier. Dramatic efforts to balance the budget look unlikely, but so does the expansive investment the President-elect Joe Biden promised for infrastructure, education and climate mitigation.
In Europe, early rebounds in PMIs look promising even as governments introduced more stringent measures while COVID cases continued to rise. The winter data will likely deliver grim news as mobility remains constrained and precautionary household savings rise. Continuing weak inflation numbers reflect the weakness in overall demand, but they also gives the European Central Bank plenty of room to expand credit to the banking system and support more fiscal spending through its expansive purchases of government bonds. Approval of the European Union Recovery Fund confirmed government commitments to boost fiscal support, which should deliver results within months, while the U.K. adjusts to its fresh trade deal with the continent.
Asia’s recovery continues on strong demand from China, where both industrial and consumer activity continues to improve. Chinese demand has also bolstered the region’s trade flows, although over the longer term Asia will need to adjust to a Chinese economy that is headed for more moderate growth rates. Japan’s commitment to a significant new fiscal package looked promising, although its real impact will depend on structural reforms that will take years to assess. Meanwhile, new lockdown measures will hurt first-quarter activity.