Fears about the new COVID-19 variant and about the wave of infections hitting Europe seem to have subsided. This uptick in optimism led to a decline in stock market volatility last week. The VIX index, which measures the volatility of US stocks, was down 40%.
Last week, US jobless claims were at their lowest since the pandemic started in March 2020. The jobs market has largely returned to normal in recent months, and unemployment should continue to decline. This is likely to push up US consumer confidence.
Oil prices, buoyed by very bearish sentiment and reassuring news about the Omicron variant, have rebounded sharply from their recent lows. This uptrend should continue, provided that mobility statistics keep improving.
The link between inflation and interest rates is so last century !
People in Europe and North America probably feel like they keep living through the same nightmare – just like in the film Groundhog Day. The recent surge in cases in Europe and then North America seems very similar to previous waves, especially the one we were going through at this time last year.
Luckily, a large part of the population is now vaccinated, so the consequences have not been quite as dramatic in terms of hospitalisations and deaths. And the authorities have managed to avoid imposing strict lockdowns, which means that there should be less of an economic impact. It won’t be like Q4 2020, when GDP contracted by 2% year on year in Switzerland and the US and by more than 4% in the eurozone.
The out-
look for the current quarter is much brighter, as GDP is expected to grow by just under 4% year on year in Switzerland and could even hit 5% in the European Union and the States. It looks like the world has finally got used to living with COVID-19 and its many variants.
The last 12 months have been a real game changer when it comes to inflation too. In the US, in particular, inflation has surged, with prices rising by close to 7% over the past 12 months, versus a rate of 1% this time last year. The increase is almost as sharp in Europe, where prices are up 4.9%. In Switzerland, however, inflation remains under control, at 1.5%. In the past, such a sharp, synchronised rise in both growth and inflation would usually lead to a surge in bond yields.
But this time around, long-term interest rates have risen by just a few tenths of a percent. Ten-year yields have levelled off at around 1.5% in the US and remain stubbornly negative in Germany and Switzerland, at –0.35%. Has the link between interest rates, on the one hand, and economic growth and inflation, on the other, been broken for good? It’s still too early to know for sure.
Starting next year, central banks will begin scaling back their asset purchase programmes, which will automatically increase the volume of bonds available to conventional investors. That’s when we’ll see whether investors still expect to be compensated for inflation like they used to be.
China - a long-awaited change of tone
Last Monday, the Chinese authorities announced their decision to cut the reserve requirement ratio for banks – a sign that Beijing is finally focusing on stabilising growth and becoming more accommodative. This change in tone, which had been expected for several months, has happened at a time when the US and Europe are starting to tighten their monetary policy. It is a show of support for the Chinese economy, in response to growing fears about the country’s contracting property sector.
The risk of contagion from the Evergrande debt crisis seems to have been contained, so the Chinese government will, if possible, continue its reform of this sector, which it had only just started.
Last week, the People’s Bank of China also announced that it would raise the foreign exchange reserve requirement ratio. This sent a clear signal to the markets that Beijing intends to rein in the Chinese yuan, as a strong yuan could make Chinese exports less competitive and hinder growth. A rising yuan is particularly concerning because exports are one of the few drivers of growth, given that the property sector is running out of steam and new COVID-19 waves continue to weigh on consumer spending.
Demand for Chinese exports in the US and other major economies will remain firm in the short term thanks to new restrictions. And so exports should only start to slow, gradually, in 2022. In the meantime, let’s hope that this new, more accommodative stance will help other drivers of growth pick up some of the slack.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
