Our Q2 2021 Outlook - Inflating Expectations

Macro
With infection rates still stubbornly high across the EU, vaccine shortages hampering inoculation programmes and lockdowns being extended, it is looking increasingly likely that the euro zone may not exit recession until Q3. However, global business confidence strengthened in March and fiscal and monetary policies remain powerful supports – we continue to expect a synchronised global upturn in H2. China has completed its recovery from the pandemic crisis and authorities have signalled that less policy support is now required. Moreover, with President Biden now advocating at $3 trillion infrastructure investment plan (taking fiscal spending since December to 27.8% of GDP), overheating will remain a concern for economists.

Central 
Banks Recent central bank meetings have confirmed that policy will remain very easy. Despite upgrades to this year’s growth and inflation projections, the Federal Reserve (Fed) still sees no need to raise rates before end-2023. And the European Central Bank (ECB) has reacted swiftly to some modest tightening in financial conditions by announcing a “significantly higher” pace in asset purchases over Q2. Economists expect a spike in inflation measures this spring as the enormous rise in raw material prices over the past year feeds into the data but central bankers remain unperturbed, judging that this will be a transitory phenomenon.

Markets 
The macro environment of rising inflation expectations fuelled by fiscal spending has pushed sovereign yields sharply higher since last summer, particularly in USD and GBP, and further upside is possible. Corporate bond spreads (the difference in yields with sovereigns) remain tight, offering little value for investors. In the near term, recent dollar strength might persist given widening growth and yield differentials vs the euro zone but, longer-term, fundamentals should weigh on the greenback. Global equity markets remain close to mid-February’s all-time highs but there has been a shift away from highly-valued growth stocks towards cheaper, more cyclicallysensitive sectors and regions.

Bottom line
Equity markets have risen steadily since end-December and valuations now face a challenge from rising yields – we have scaled back exposure but remain Overweight. Within regions, we have locked in some profits on emerging markets and upgraded our view on the UK. We also continue to highlight the attractions of “Value” stocks and sectors (which rank as cheap on ratios such as price-to-bookvalue, dividend yield and price-to-earnings). No changes to our negative view on advanced-economy sovereign bonds and we also remain Underweight on credit (corporate bonds). We continue to expect the euro to regain ground against the dollar as cyclical recovery takes hold in H2.

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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 statistics and figures in this report were taken from Bloomberg and Datastream on 26/03/2021