The eternal zero

The eternal zero

The most famous quote from The Leopard by Giuseppe Tomasi di Lampedusa is, of course, “everything needs to change, so everything can stay the same”. The novel chronicles the changes in Sicilian society during the Risorgimento. While the context is very different, our Counterpoint 2021 tells a story of change and continuity too. Vaccines will likely allow the reopening of vast parts of the economy this year – quite a change from a full year of lockdowns. But one thing will stay the same: the policy drivers of financial markets. For what will feel like an eternity, central banks will continue to adapt their monetary policies to anchor real rates in negative territory, allowing governments to borrow at near-zero to continue to boost growth via fiscal stimulus. This implies gaining exposure to asset classes that perform well in early cycle.

Policy driver #1 | Monetary anchor: Moving into the early stage of a new cycle typically means rising yields and steeper curves. To some degree, this is happening this time around too. Yet, unlike past cycles, central banks are unlikely to tighten their policy stance anytime soon, given high levels of debt and an ongoing need for stimulus, along with below-target inflation levels. While they won’t suppress each and every small increase in interest rates – especially if it has to do with expectations of an economic improvement and/or additional bond issuance – they’ll probably continue to make funding very affordable for governments and the private sector alike, mitigating credit impairment.

Policy driver #2 | Fiscal boost: To support economic activity, a ‘unified blue’ government in the US is planning higher fiscal spending financed by extra borrowing. This should push inflation expectations higher – as it has over the past few months, in anticipation of this policy shift. With pent-up demand meeting supply-side bottlenecks when reopening takes place, realised inflation should pick up too, but still stay relatively low. Nominal yields should rise slightly in the US and not increase much in Europe. This means that real rates are likely to remain quite negative, continuing to make debt-financed stimulus sustainable – for governments, not central banks, to do “whatever it takes”.

Here’s why this matters:

Asset-price inflation here to stay: Monetary policy stimulates the economy when real rates are negative. With inflation still so low, this implies low nominal rates. Discounting cashflows using lower rates than in past cycles boosts the present value of risk assets. So equities and higher-yielding credit should be supported. Within equities, growth stocks such as those in the tech sector tend to be particularly sensitive to interest rate movements. This means that the early phase of the cycle, when bond yields are still low but rise a bit, could bring investment opportunities in areas that are more linked to improving activity, such as cyclical stocks, smaller businesses and/or sectors that have been hard-hit by the pandemic and, therefore, may benefit disproportionately when reopening happens.

When cyclical and structural collide: This doesn’t mean that it should be a negative environment for growth stocks: over the medium term, they are likely to continue to benefit from very low interest rates in real terms. But the combination of early-cycle dynamics and rock-bottom real rates could trigger a rotation within the tech sector, with investors looking to gain further exposure to more cyclical subsectors, such as semiconductors. In addition, low rates mean that investing in private assets could enhance overall returns, due to the relatively low expected returns from public markets. These opportunities for return enhancement could include private equity, private credit, venture capital, select infrastructure and property, and hedge fund-based multi-strategies.

Meanwhile, plenty to watch out for…

Change of guard: After another rollercoaster week in US politics, President-elect Biden is set to be inaugurated on January 20. He’s wasting no time to push for greater fiscal stimulus – all deficit-financed. This is fuel for the reflation trade. China growth continues to surprise to the upside. Despite the economic recovery, slower credit growth will probably buy the People’s Bank of China some extra time – we don’t expect any policy tightening for a while longer. The purchasing managers’ indices out for Europe, Japan, and the US should show less weakness compared to earlier lockdowns, as economies have adapted to a greater extent. The European Central Bank, after having expanded its asset buying programme last month, should remain on hold – but the message is likely to stay dovish.

Daniele Antonucci | Chief Economist & Macro Strategist

This document has been prepared by Quintet Private Bank (Europe) S.A. The statements and views expressed in this document – based upon information from sources believed to be reliable – are those of Quintet Private Bank (Europe) S.A. and are subject to change. This document is of a general nature and does not constitute legal, accounting, tax or investment advice. All investors should keep in mind that past performance is no indication of future performance, and that the value of investments may go up or down. Changes in exchange rates may also cause the value of underlying investments to go up or down.

Copyright © Quintet Private Bank (Europe) S.A. 2021. All rights reserved. 

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