Weekly review: Boris’ big gamble

Macro Update 12 July 2021
July 2021
Steven Bell

Steven Bell

Managing Director, Portfolio Manager & Chief Economist, Multi Asset Solutions


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Risk Disclaimer

Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Key takeaways

The UK is set to abolish almost all of its Covid restrictions even as new cases soar – how might this end? The US Federal Reserve Chair addresses Congress in a week that sees key US inflation data, the European Central Bank will announce changes to its inflation target, and China cuts its key reserve ratio – another big week for markets.

With a vaccine roll-out that has seen double jabs for the overwhelming majority of people who are vulnerable to Covid either due to age or pre-existing medical conditions, the government have decided to ‘let it rip’ by abandoning almost all restrictions. This is despite a rapid rise in new cases due to the Delta variant and huge numbers of men crowding into pubs to watch the football – 30% more men than women tested positive in recent weeks. The vaccine has weakened the link from infection to hospitalisation and death. But it hasn’t severed it completely and both are set to rise rapidly.

Is the UK headed for disaster?

I’m very worried about the next few weeks but the gamble might just pay off. In effect, the UK has decided to live with Covid, to have the rise in pressures on the National Health Service in the summer, when they are best able to cope. The rest of the developed world will probably follow. The US is nearly there already.

This means that global recovery, led by developed markets, should continue and the reflation trade remain intact. It’s a different story in emerging markets, but China has super-charged its vaccine roll-out and should be in the same position as the UK and US are now by year end.

Vaccines remain highly effective against the Delta and other variants. Even if a more dangerous variant does emerge, experts are confident that they can tweak their vaccines in just a few months. So, this is the new normal in the world of Covid. Just as we live with the flu, albeit more contagious and nastier.

A shift in the inflation measure

Fed Chair Jerome Powell will testify to Congress in the characteristic cautious way. Explaining that inflationary pressures are transitory, and that the Fed will support economic recovery. Meanwhile, the European Central Bank will up its inflation target from ‘close to but below 2%’ to one that is symmetrical around 2%. Is this an easing of policy? No, not at all, because the target will shift to a CPI measure, which includes housing and is a shade above the current measure.

As we go into Q1 earnings season, what does all this mean for markets?

Despite my optimism about the world economy, it’s hard to see significant gains from equities.  There is so much priced in. Yes, companies are set to beat analysts’ estimates yet again; banks will lead with the consensus assuming they will have to increase their loan loss provisions. But the reality is that they’ll be reducing them as they did last quarter.

Investors have become habituated to companies heavily beating estimates. They no longer reward companies that do so with higher share prices. Of more interest will be corporate guidance. How long do companies expect production to be curtailed by a shortage of components like semiconductors. Are they able to recruit enough workers? Is inflation likely to persist and are margins under pressure?

With bond yields so low and economic recovery underway, risk assets seem to be the place to be. I still think it’s too early to pile into emerging markets, but overall, modest outperformance by developed market equities looks likely to characterise the rest of the year. This will look wobbly in the UK over the summer and I am no longer optimistic about sterling as a result, but the days of lockdown could well be over.

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