The US central bank has used the pandemic to reverse a major policy error but it has taken thousands of deaths and a lockdown crisis to force governments to do their bit and start spending.

 

Prior to the Covid crisis, the global economy was heading into recession. US interest rates were too high and tough regulations restricted bank lending. In addition, Donald Trump’s trade wars and tweets scared investors so global capital beat a retreat from emerging markets to the safe haven of the dollar which strengthened, undermining global growth.

Having first cut interest rates, the big policy change came in September when the US central bank said it would target jobs growth and tolerate higher inflation. The implication that interest rates would remain low for a long time provided the much needed trigger for the dollar to weaken. This injection of dollars back into the rest of the world is the reflationary vaccine the global economy sorely needs.

Fiscal cliff is a near term danger

Scarred by the 2008 global financial crisis, companies halted investment and consumers shunned spending, using spare cash to pay down debts. When consumers stop spending economies face stagnation unless the state steps in as spender of last resort. But politicians made things worse by insisting on austerity – spending cuts. That’s why in 2012 Ben Bernanke coined the vivid phrase ‘fiscal cliff’ to remind US politicians their harsh budget plans risked pushing the economy into recession.

In late 2020 they need to be reminded again as short-term fiscal support packages to protect workers are set to expire before longer-term major infrastructure spending can create new jobs. Once again, we expect US politicians to realise this, but only at the eleventh hour.

In the UK, Chancellor Sunak has already announced a raft of schemes to offer support and help create new jobs. Meanwhile, although some may see the EU’s wrangling over its €750bn recovery fund as typical euro-sclerotic tardiness, the inevitable delay in spending this money means it could come at a more opportune time and provide a second tailwind to global growth.

Now’s a good time to increase exposure – but differentiation is key

With US election uncertainty behind us and Covid-19 vaccine rollouts imminent, we believe now is a good time for investors to increase their EMD exposure. Following large outflows earlier in the year, we are already seeing money return to the asset class – and several market surveys show that investors are expecting to increase their EMD allocations in 2021. Though it’s still significantly underrepresented globally, the $23tn asset class is increasingly becoming a core part of investors’ portfolios: with over 90% of the fixed income universe yielding less than 3%, EMD is one of the few places investors can get a decent yield.1 We expect allocations to continue to pick up.

 

As always, we believe that differentiation is key when investing in a vast, diverse asset class like EMD. By taking a flexible, active approach, we are able to respond to new information as it becomes available and to take advantage of indiscriminate sell-offs when they arise, while also managing drawdowns. We can of course expect some market volatility in the short term, but we believe that the macro backdrop looks supportive, and our fundamentals-focused research should help us to identify both corporate and sovereign names with strong longer-term potential.

 

 

INFOGRAPHICS_Mark_Nash Outlook 2021

Persuading banks to lend

Meanwhile in the UK, commentators seem pulled between seemingly contradictory fears on the one hand that inflation is about to make an unwelcome comeback and, on the other, that the Bank of England will cross the Rubicon into negative interest rates – crushing savers and seeing anyone with a bank account stung for extra charges.

 

Negative bank base rates would send a signal to the British public that something was seriously wrong and, post Brexit, kill off what little confidence is left. However, in my view, negative rates are unlikely. That’s because of a nifty device called the Term Funding Scheme which lets banks borrow profitably at less than the base rate provided they lend the money to businesses and households. But what if fear of rising bad debts stop them from lending? No matter. The government is stepping in and incentivising them with various credit guarantees because it needs the banks to be conduits of its stimulus.

 

Karl Marx once urged workers to seize the means of production. It now looks like we are transitioning to a new era where governments are seizing the means of money creation from central banks. The so-called ’money printing’ of quantitative easing (QE) failed to create inflation because the ballooning money supply stayed trapped within the financial system.

 

But if – and it’s a big if – the government makes excessive use of credit guarantees to encourage ‘risk-free’ lending then the associated money creation could leak into the real economy potentially leading to inflation and nominal economic growth. That would be one way of reducing the debt burden. Even if inflation ticks up, governments will still be able to issue bonds with low coupons because their central banks can hoover them up with further QE. Lots of countries had high debt burdens after World War II but they managed to de-lever over subsequent decades. This time may not be any different. Covid may eventually be controlled but policymakers are unlikely to quarantine their new toolkit so bond investors will need to expand their own toolkits, too.

INFOGRAPHICS_Alejandro Outlook 2021

Please note:

Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.  The views expressed are those of the author at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change.  This is particularly true during periods of rapidly changing market circumstances.

Important information

This document is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. For definitions please see the glossary at jupiteram.com. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Holding examples are not a recommendation to buy or sell. Issued by Jupiter Unit Trust Managers Limited (JUTM) registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority. No part of this document may be reproduced in any manner without the prior permission of JUTM. 26684