Weekly review: will the delta variant kill the reflation trade?

Macro Update 5 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
There’s lots to talk about this week. The impact of the Delta variant here in the UK, but also in Europe and the US. Important data from China, plus a look ahead to the earnings season for companies in Europe and the US. And I’ll try not to mention the football…

Let’s start with the Delta variant in the UK and how it might spread elsewhere. I must confess that I was rattled by the data on Friday from the Office for National Statistics (ONS) on infections and hospital admissions. Daily data on headline infections have been soaring but these can be distorted because they rely on people getting tested. The more reliable ONS numbers are based on controlled random sampling. They had been growing much more slowly but the latest figures leapt up with a rise of 67% on the previous week. Hospital admissions too have risen: it looked like they had stabilised at 250-a-day but the last two daily figures have risen above 300. Another problem is England’s progress in Euro 2021 football championships. This is of course a welcome, if unexpected, development for us but it does involve millions of supporters crowding into pubs and other venues to cheer on the team; Super Spreaders United.

Still optimistic on the UK economy and sterling

Nonetheless, I’m sticking to my optimistic view on the UK and on sterling, albeit with less confidence. It is still true that the link from infection to hospitalisation has been weakened. New cases are dominated by the under 30’s, with lower vaccination rates and a greater tendency to have more social contacts. The pressures on the National Health Service should be containable. The economy should continue to boom.

The UK looks set to announce that most remaining lockdown restrictions will be removed from the 19 July, though the final decision will be taken on the 14th. Travel restrictions will remain but quarantine will be eased for those fully vaccinated, although governments still need to iron out the problems with recognising each other’s vaccines (a particular problem with the US who do not recognise the AstraZeneca vaccine. The next big decision relates to the test and trace system: given lockdown easing many more social contacts are ‘pinged’ by the NHS app and have to self isolate. This is becoming unsustainable and seems especially crazy for those who have been fully vaccinated.

School disruption has a big knock on effect for parents and the economy

It is especially disruptive for schools with a big knock on effect for parents and the economy. The government want to vaccinate children, the Joint Committee on Vaccines and Immunisation disagree. The decision is being delayed until well into the summer holidays when we will have data on side effects from countries like the US who are vaccinating teenagers. It is not an easy choice: either let the virus rip through schools or risk side effects from vaccinating children who are unlikely to suffer much from Covid.

Europe and the US are bracing themselves for a new wave of infections from the Delta variant. They, like the UK, look set to resist re-imposing restrictions; in effect the plan is to live with the virus protected by vaccines.

What does all this mean for the world economy and financial markets?

The boom in developed economies looks set to continue. Currently led by the US, we will see a surge from the UK and Europe over the next few months. Emerging markets will continue to lag. Indeed, China continues to slow, with a weaker credit impulse (a measure of the growth of new financing), a fall in the composite Purchasing Managers’ Index and steeply negative economic surprises.

In terms of equity markets, this month sees the reporting season for Q1. We expect good numbers on earnings and revenues, but it seems most unlikely that companies can match their recent record of huge ‘beats’ versus expectations. I expect a lacklustre response from equities. I covered the inflation threat in last week’s update and explained why I fear a second wave of inflation pressure in the US, even as the bottleneck price rises we’ve seen so far this year begin to ease.

All in all, I believe equities will end the year a little higher from here, outperforming cash and bonds. The second half won’t be as good as the first, but the final score should still see a victory for risk assts. The reflation trade survives.

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