Q2 | 2021

Global Macro Outlook

A period of divergence

Macroeconomic themes that could shape the financial markets in the months ahead

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Macroeconomic Strategy, Multi-Asset Solutions Team

Key themes

Timeline

  1. Inflation

    We expect headline inflation in the United States to rise significantly in Q2 to highs rarely seen in the past decade. Where the financial markets are concerned, what matters is whether inflationary pressure will persist into Q3 and Q4. We don’t expect it to, but it’s worth noting that any evidence of sustained inflationary pressures above 2.5% on a year-over-year basis is the largest—and most important—risk to our outlook (and the markets).

  2. Central bank speak

    Central bank communication can represent a risk in the coming quarter as policymakers begin to look for ways to normalize monetary policy without exacerbating the sell-off in the bond market. Reaching a happy medium isn’t likely to be a smooth process—expect bouts of volatility in fixed-income markets as the yield curve continues to steepen gradually and interest rates climb.

  3. Catching up: global services sector

    We expect the global services sector to catch up fairly aggressively with global manufacturing activity in Q2. That said, it’s worth questioning if the global industrial complex (including commodities) can maintain the current level of strong performance throughout the entire quarter—it’s one of the few downside risks to our outlook.

  4. Emerging markets

    We remain long-term, strategic believers of emerging-market (EM) assets—both equities and debt. However, peak liquidity, the expected appreciation of the U.S. dollar (however brief), and the slowing growth momentum in China suggest that EM assets could experience mounting headwinds in the coming months. We view any periods of underperformance as an opportunity to reengage.

  5. Domestic economic structure

    While investor focus will no doubt be on the great reopening of the global economy, much of the growth outlook for many economies continues to be defined by domestic structural challenges—from persistently low inflation (Japan) to systemically low levels of fiscal support (Europe) to potential housing bubbles (Canada).

While vaccine rollouts and the rate at which COVID-19 evolves remain the largest risk to the highly anticipated great reopening of the global economy, we no longer see the pandemic as the most important macro driver in the coming months."

—Frances Donald, Global Chief Economist and Global Head of Macroeconomic Strategy

U.S. economic outperformance likely to continue

The United States has outperformed most developed economies since the start of the year and should continue to do so throughout 2021. Key drivers include sizable fiscal stimulus, likely additional infrastructure spending, and an accelerated vaccination rollout. The ramp-up in the pace of the inoculation program has helped to normalize mobility levels and should continue to do so. It should also lead to a surge in services spending, along with a jump in services sector employment. As we get closer to business as usual, we expect the Fed to prepare the markets for the eventual unwinding of quantitative easing, which we believe will begin before the end of 2021.

  • Key market views

    Equities

    Given that the S&P 500 Index appears to be fully valued, we expect modest index-level returns to take a back seat to stock selection and sector rotation to take place as the next phase of the pandemic plays out.

  •  
    Interest rates/yields

    While we expect a modest decline in rates following an aggressive rise in Q1, we ultimately believe the 10-year interest rate could rise to 2% by year end; crucially, the path higher is likely to be volatile and driven by Fed communications. We expect the yield curve to steepen aggressively as the 30-year yield continues to climb while the Fed attempts to keep the 2-year yield well contained.

Canada: a strong second half likely

We believe the Canadian economy is on track to follow the developed world with a robust second half, led by a sizable pop in services activity; however, a slower vaccination schedule means that Canadian recovery is likely to be slightly delayed. Interestingly, the Bank of Canada (BoC) has tied its monetary policy response to the pace of vaccinations rollouts, thereby suggesting a slower pace of monetary policy normalization is likely. That said, Canada’s fiscal response is stronger relative to its developed peers, which we believe will continue throughout 2021. This should provide ample support to the economy, particularly the Canadian jobs market.

  • Factors to monitor

    Housing sector

    Housing activity remained robust throughout the pandemic with low interest rates providing meaningful support to sales activities. We’re seeing evidence of speculative activity and believe there's heightened probabilities of some form of regulatory response.


  • Bond-buying program

    The BoC’s holding of Canadian government debt, as a share of the market, is particularly high relative to the United States. The bank may need to make adjustments to its bond-buying program to avoid distortions in the market. That said, any policy action could be paired with a commensurate form of easing to avoid any unwarranted tightening of financial conditions.

Will China's growth momentum continue?

Details from China’s National People’s Congress support our view that the Chinese economy has hit a cyclical peak. The 2021 GDP target at over 6.0% is well below consensus estimates of around 8.4%¹ and should be easily achieved through base effects without the need for additional stimulus. Indeed, China’s political leaders have set out to tighten the fiscal deficit from 3.6% to 3.2%¹ with no mention of a lower overall interest rate, a sign that monetary support could be less accommodative going forward. Credit will also be tightened aggressively, by approximately 20.0% from the previous year, signaled by a pledge to keep growth in money supply and aggregate financing to the real economy in line with nominal GDP growth.²

  • Credit growth

    The Chinese government targets a much weaker credit impulse this year relative to 2020. The expected slowdown in credit growth will weigh on the wider economy in the second half of the year. 

  • U.S.-China relations

    Review of critical supply chains, which is aimed at insulating the United States from shortages of critical imported components—such as semiconductor chips, large-capacity electric vehicle batteries, rare earth, and pharma—is due to take place by early June. Tighter U.S. import controls will likely affect Chinese exports, the key pillar of China’s economic growth last year.

Previous editions of Global Macro Outlook

U.K. economy: growing optimism

The United Kingdom’s relative success in vaccine rollout puts it head and shoulders above most other major developed economies and offers a tailwind for growth in 2021. At this juncture, the United Kingdom is poised to capture even greater upside—at least on a relative basis—as its services sector benefits from the expected relaxation of social distancing measures. The recent U.K. budget also surprised to the upside, offering a fiscal tailwind to assist in the economy’s reopening over the next couple of quarters. Inflation expectations in the United Kingdom aren’t only well anchored, but also relatively elevated, having traded solidly above 2.0% over the past five years or so.³

1 Full Text: Report on the Work of the Government,” xinhuanet.com, March 12, 2021. 2 China’s Central Bank to Step Up Efforts to Curb Financial Risks,” Bloomberg, March 9, 2021. 3 Bloomberg, as of March 23, 2021.

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Important disclosures

A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.

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