EC February 2021 Monthly Outlook

Most of the time, investors are focused on two V’s: value and volatility. However,  two other V's will continue to dominate the month ahead for the investment climate: virus and vaccine. At the end of January, it seemed like many high-income countries had begun seeing leveling-off after the holiday-inspired surge. Economic-cramping restrictions will remain in place for the next several weeks, and many consider deepening and/or broadening restrictions.  

The IMF boosted this year’s outlook and sees world growth at 5.5%, up from 5.2% in October. If accurate, it would be the strongest growth since 2010’s recovery from the Great Financial Crisis. The chief economist Gopinath commented as the new forecasts were published that “Much depends on the outcome of this race between a mutating virus and vaccines and the ability of policies to provide effective support until the pandemic ends.” 

Fiscal stimulus from late last year by the US and Japan were taken on board by the IMF, and it revised 2021 growth higher its update.US 2021 GDP is now estimated to be 5.1% rather than the 3.1% it projected last October. The prospects for more stimulus mean that there is upside potential in the IMF’s next update. Japanese growth was revised up to 3.1% from 2.3%. Growth in the eurozone was downgrade to a still-solid 4.2% from 5.2%. 

The IMF seemed particularly optimistic about India. Last year’s contraction is now estimated to be around 8% of GDP rather than more than 10%. It is the 2021 forecast of 11.5% (from 8.8% in October) that grabbed attention. China’s growth prospects were shaved to 8.1% from 8.2%.In 2022, the IMF also projects India to grow faster than China (6.8% vs. 5.6%). 

Most of the G7 are at risk of contracting in the first three months of 2021. The main exception is the United States, helped by the $900 bln fiscal packages approved at the end of 2020. Although President Biden has proposed a new $1.9 trillion stimulus bill, it is best understood as an opening gambit that will most likely be negotiated down. The IMF estimated that the stimulus proposal if adopted, would boost growth by 1.25% this year and 5% over the next three years. Debating over the size and priorities of this package will likely dominate the month ahead. Ideally, it will be resolved before the extension of jobless benefits ends in the middle of March.

A new divergence appears to be opening between the US and other high-income countries. The preliminary Purchasing Managers Survey for January is a case in point. The composite reading for the eurozone was 47.5, the third month below the 50 boom/bust level. At the end of 2019, it was at 50.9. Japan’s preliminary January composite PMI stood at 46.7. It has not been above 50 since January 2020. In stark contrast, the US preliminary composite PMI rose to 58.0, and it was the fourth month above 55.0. In December 2019, the composite was at 52.7.

Although based on comments from the Governor of the Bank of Canada, a window appeared to open in favor of a mini-rate cut (10-15 bp), but for the most part, barring a new undesirable turn of the virus, we are probably near peak monetary policy in this cycle. In the US, several regional Fed presidents are open to the possibility of tapering the long-term asset purchases this year. Chairman Powell wants to stay focused and ensure a robust recovery and argues it is premature to. In the ECB, there seems to be an agreement that the full 1.85 trillion-euro Pandemic Emergency Purchase Program does not have to use if favorable financial conditions can be preserved with less. 

In late January, ECB officials warned that investors were underestimating the risks that it reduces rates again. The ECB’s dual rate regime, whereby the deposit rate (minus 50 bp) is not functioning as the floor for money market rates because the central bank makes loans (TLTRO) at minus 100 bp if certain lending targets are reached. It is difficult to tell precisely what has been discounted, but we note that the key overnight benchmarks are six-eight basis points below the deposit rate. The implied interest rate on three-month Euribor futures contracts is below the deposit rate by as much as eight basis points until September 2023. 

ECB President Lagarde has repeatedly indicated that its measures are scalable in numerous dimensions. The PEPP was symmetrical. The full authorization need not be drawn upon, but if more was needed, it would be provided. The risk of an ECB rate cut has not been more pronounced, maybe because it would likely be a 10 bp move, which may be too small to have much impact. And to think that it would have more than a short-term impact on the foreign exchange market or that it would boost CPI seems somewhat naïve. 

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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