The numbers game

There’s an old riddle about a lily pad in a pond: the lily pad doubles in size every day and after 30 days it completely covers the pond; on what day does the lily pad cover half the pond? If you answered without really thinking about it, you probably answered “day 15”. Our mind tends to think linearly: if the lily pad covers the entire pond in 30 days than it must cover half of it in 15 days. Of course, if you paused to think about it, you’d realised that the lily pad only covers half the pond on day 29 and then doubles again to cover it entirely on day 30. This is an illustration of how the Covid-19 pandemic spreads: after a few iterations, the numbers rise very quickly. What happened over the past few days, therefore, is crucial: the number of Covid-19 vaccinations has surpassed the total number of confirmed cases globally – a key moment that underscores significant progress. Let’s have a look at the risks around our forecast of continued improvement.

Upside risks | (Party) ‘animal spirits’: John Maynard Keynes used this term (of course, without the ‘party’ bit) to refer to the instinctive, emotional aspects of business activity. Two drivers have the potential to fast-track the recovery, both related to these aspects but more driven by the consumer this time around. First, the rebound we project from this spring could be stronger than expected – as pent-up demand may be released faster than envisaged. The lockdowns turned out to be more protracted and, therefore, large amounts of ‘forced’ savings have now accumulated. Second, the feed-through of policy stimulus could be stronger than expected too. While we assume that the private sector will smooth its consumption – partly saving the transfers from the public sector – it’s possible that, initially, the response to all this monetary and fiscal support is a good dose of catch-up spending.

Downside risks | A pandemic flop: The potential threats are two as well. First, a challenge to either vaccine distribution or efficacy (or even safety) is the single-biggest risk to our view of recovery and reflation. An extreme version of this scenario is an unpredictable ‘black swan’ such as the outbreak of a new virus. Second, a premature shift to monetary stimulus withdrawal, once the Covid-19 pandemic is overcome, would challenge a key pillar of our forecast. Inflation is likely to rise temporarily this year and we expect central banks to continue to signal that they’ll look through it. But markets could demand more premium against the risks of earlier tightening, even if that worry eventually proves incorrect. Similarly, high debt levels may make investors worry about unexpected fiscal tightening, though to us this is an extra reason for monetary policy to anchor funding costs at low levels.

Here’s why this matters:

Staying the cyclical pickup course: While rate shifts could become a more prominent source of volatility this year, we think that cyclical assets will be able to move higher even if yields do too. Apart from their still-low absolute levels, this is because we expect central banks to mitigate the pace of any yield rise and delay policy normalisation to ensure that economic growth reaches escape velocity – when it becomes more self-sustained. This means that, despite potential real rate headwinds, pro-cyclical exposures should continue to perform well, although the gap between this view of cyclical improvement and market pricing, at this point, has narrowed. These exposures range from smaller businesses and sectors that benefit from accelerating growth to those that have been negatively impacted by lockdowns to a greater extent and, therefore, stand a better chance to outperform.

Coping with market volatility spikes: While things appear to have calmed down at the moment, the week before last turned out to be one of the heaviest for ‘de-grossing’ over the past decade. The unwinding in equities was led by speculative investors both covering their short positions and selling shares more generally to cut their leverage and reduce their gross exposure to the market. The retail-driven squeeze in some heavily shorted names shows that, in large enough numbers and with the help of low-cost and easily available trading apps, these investors can cause sharp price movements. While this episode of volatility doesn’t pose a direct threat to the global economy and to the market at large, it does illustrate how financial vulnerabilities can show up in unexpected places and strain confidence, at least for some time, more or less regardless of the fundamental picture.

Meanwhile, we’re watching several things…

A look around the world: US nonfarm payrolls turned out to be rather lacklustre and below expectations. While the virus weighed on the leisure and retail sectors, payroll growth was generally weak across the private sector. We expect continued growth in the US, but at a relatively slow pace this quarter too. Without any headline-grabbing data releases this week – apart from perhaps US inflation – market participants may focus on some of the numbers out of China: Chinese New Year is in February this year compared with January in 2020, and so the high base will likely drive down the annual inflation rate; the money supply and credit data out during the week may be worth watching for any sign that tighter restrictions are impacting activity ahead of the New Year holiday. In Europe, Germany will reassess the lockdown measures this week, and former European Central Bank president Mario Draghi will get on with government formation in Italy.

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.

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