Weekly update: Reflation still underway despite Delta variant

We economic forecasters often describe our job as ‘peering into the fog’. Well that fog is lifting a bit on the US labour market and has....
June 2021
Steven Bell

Steven Bell

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


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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

Reflation still underway despite Delta variant

We economic forecasters often describe our job as ‘peering into the fog’. Well that fog is lifting a bit on the US labour market and has thickened a bit in the UK as a result of the Delta variant, originally detected in India. We’ll turn up our own fog lights and see what they shed on the outlook for equities, bonds and sterling.

US labour markets are labouring

Let’s begin with the US labour markets. Non-farm payrolls showed strong growth in May but it was below market expectations, following an even more disappointing number in April. Does this show demand for workers isn’t rising as rapidly as we expected? No, the evidence suggests that firms are clamouring for workers, but they just can’t recruit them fast enough to meet surging demand. Many workers were staying at home because schools weren’t fully open last month. With women typically bearing most of this burden disproportionately, many have simply dropped out of the workforce. Many low paid workers are better off with their enhanced unemployment benefits than going back to a low paid job. Many older workers are still living off their stimulus cheques.
All of these limitations are temporary: the schools are going back (seasonal adjustment kicks in when the holidays begin too), enhanced unemployment benefits are being stopped in 25 states this month, and end everywhere in early September.

But wages are strong

And wages are rising too – they’re strong than expected – despite the fact that the newly hired workers are generally low paid, which should drag down the average. Breakeven inflation is above 2%, not just at the 10-year average but also at the 5-year rate 5 years forward, which is the measure that the US Federal Reserve (Fed) focus on.
We are still 7.4 million jobs short of the pre-Covid level, so full recovery will take time, but I think the Fed will be tapering by year end and will increase the Fed Funds Rate in 2022, which is earlier than I thought previously. Of course, there is a thick fog of uncertainly around this forecast but the pressures is for bond yields to rise further.

More volatility and modest gains for equities

As for equities, the big gains for this year are behind us, after 4 blow-out earnings seasons. It’ll be tough to impress the markets in the next earnings season starting in July. I reckon we’ll have a more volatile time and modest gains in global equities over the rest of the year.

There are questions over the 21 June easing in the UK

Back in the UK, our economic recovery is from a lower base and is more concentrated than in the US. That does depend on further easing of restrictions on the 21st of this month. I think that easing will go ahead but not to the full extent as outlined in the road map. The government will be especially cautious on easing foreign travel. The vaccines have dramatically weakened the link from catching Covid to hospitalisation and fatality, whether it’s the Alpha or Delta variant. And it’s much better for all concerned – including the NHS – to have the inevitable third wave in the summer.

Bullish on sterling… for now

As far as sterling is concerned, I remain bullish, as I believe the gloomy headlines over lockdown easing in the UK will be shown to be overly pessimistic. But the boom in consumer spending on everything from cars to BBQs means that imports will rise. We already have a huge deficit and, tourism aside, it is set to get a lot worse. So, I’d move neutral if sterling hits 1.45 versus the US dollar.

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