The devil is in the timing

Former US President Harry Truman once pleaded “give me a one-handed economist”, having tired of his advisers proclaiming “on the one hand, this” but “on the other hand, that”. The investor debate on whether rising bond yields and, potentially, higher inflation (however transitory) are signs of recovery and reflation or, rather, a market setback as central banks may tighten policy, feels a bit like this. It appears to have impacted the valuation of growth sectors such as tech (though they have started to recover lately), via a slightly higher discount factor. At the same time, more cyclical sectors, along with those that may benefit from reopening and a steeper yield curve, have tended to outperform. This rotation is typical in times of early-cycle recovery. It doesn’t contradict a structurally positive view on technology and innovation.

The drivers of the outlook differ according to the time horizon one looks at:

Immediate horizon | Few months: It has to do with unforeseen shocks, such as pandemics and natural disasters, unseasonal temperatures, workers’ strikes and other transitory activity setbacks, political events and even episodes of unrest. It’s about the more visceral, knee-jerk reaction of consumers, producers and investors. Rarely, some of these shocks have profound effects, such the lockdowns the global economy went through over the past twelve months. More often, these things end up correcting themselves one way or another. Of course, this short-term horizon can overlap with turning points in the medium-term cycle, sometimes turbocharging the directional change. And the cycle can be seen as a series of ups and downs around a longer-term structural trend – which is impacted by technological, demographic, social and regulatory developments.

Cyclical horizon | Several quarters: Its swings are mostly driven by changes in monetary and fiscal policy to maintain price and financial stability, and get the economy and markets going. What’s different this time around is that governments, rather than preferring austerity, are using their balance sheets to stimulate. And central banks aim to run the economy ‘hot’ – quite a change from the mantra of previous cycles, which was all about ‘cooling things down’ to avoid overheating. This means that, despite (or because of) rising debts, funding costs will likely remain affordable and real rates in negative territory (which is stimulative). This doesn’t mean that nominal bond yields can’t rise at all. At the long end of the curve, they can if growth picks up, but less than in past cycles. At the short end, they’ll probably stay anchored as policy rates won’t rise, as long as inflation remains well-behaved.

Structural horizon | Many years: Its key driver is productivity. Covid-19 has accelerated the shift from physical to digital and may boost economic growth. Our view is bullish on this front, for three reasons. First, breakthrough innovation: science continues to transform medicine and genetics; artificial intelligence is making progress in fields ranging from synthetic biology and robotics to natural-language recognition and driverless vehicles. Second, booming capital expenditure in technology: in the US, investment in intellectual property products, software, and computers and peripheral equipment is on the rise; spending on research and development is growing in many countries. Third, fast adoption of new technologies: the data economy is increasing connectivity among and within countries and sectors, and boosting automation in factories, warehouses, back offices and homes.

Here’s why this matters:

Spring is coming earlier: While Europe’s dataflow and virus/vaccine trends suggest that the region is lagging behind, the US is getting better sooner than expected. Vaccine rollouts are picking up (even more so in the UK), hospitalisations and fatalities are declining further, and Biden’s fiscal stimulus was approved in full size. This has put some upward pressure on bond yields, impacting risk markets. However, their absolute level is still low and we think the selloff at the short end of the curve has overshot fundamentals. Fed Chair Powell reiterated that the central bank will be “patient” through the coming, transient inflation pickup (as long as expectations stay anchored). And the Fed looks at “broad and inclusive” measures of full employment, suggesting no imminent policy tightening. Market pricing of nearly three rate hikes through 2023 seems too hawkish to us. We expect one.

Turning points and secular narratives: When the cycle turns from recession to pickup, and eventually expansion – when things move from weak and getting weaker to weak and getting better, and eventually strong – what tends to happen is that assets geared to accelerating growth outperform: cyclical stocks, sectors and investment styles, just like beneficiaries of economic reopening and steeper yield curves. Core rates typically underperform. Long-duration, growth stocks – such as tech – may be impacted by a somewhat higher discount factor, but we think the horizon that matters is a different one: the narrative isn’t driven by changes in macro policy, at least not that much; it has to do with deeper structural changes playing out over many years. And it’s through these parameters that investors should think about innovation and technological disruption.

Meanwhile, there are key central bank meetings this week…

Staying dovish: The European Central Bank will buy bonds at a faster pace to mitigate any unwarranted yield rise. The Fed will likely say that we’re still far from maximum employment conditions that would put sustained upward pressure on inflation, while acknowledging that the outlook is improving – also following Biden’s $1.9 trillion fiscal package – and a transitory inflation spike. The debate here is whether it makes sense to continue to show expectations of no rate hikes through end-2023, perhaps with some upward movement in the distribution of possible outcomes, or things have shifted enough to show one hike – which would still be more dovish than market pricing. The Bank of England’s meeting should be uneventful, and the Bank of Japan’s monetary policy review may reveal some tweaks. US retail sales and industrial production could be important too.

Daniele Antonucci | Chief Economist & Macro Strategist