Some 12 months after markets sold off in response to what the International Monetary Fund refers to as The Great Lockdown, we find ourselves in a steadily improving environment as populations begin to be vaccinated against the virus, with fiscal and monetary stimulus providing sufficient support.
As a result, some of the most dire predictions made during the rise of the pandemic have been avoided. This in turn has led to a pattern of encouraging improvements in forecasts for both economic activity and employment globally. With the development of effective vaccines and (reasonably) efficient rollout of the vaccines, we can be more confident that the resolution of the economic impact is at hand.
Fast forward vaccine
That ‘necessity is the mother of invention’, certainly rings true when it comes to the development of vaccines for COVID-19. Historically, it has not been unusual for new vaccines to take 10-15 years before they are ready for widespread use. Here, just over 12 months after the World Health Organisation declared a pandemic, we have a growing number of viable vaccines with full or emergency use approvals.
Indeed, we are already at a stage where development of second-generation vaccines is well underway. By February 2021, nearly 175 million doses had been administered in around 80 countries, with Israel leading the way with over 43% of its population having had at least one dose of vaccine1.
Extra strain of COVID-19
The speed of the global vaccine rollout, our own success keeping a lid of the virus and high export prices for iron ore have all helped the Australian economy recover strongly from COVID-19. By early March, Australia had recovered to 85% of pre-COVID strength, “six months earlier and twice as fast as we expected in last year’s October budget,” according to the Federal Treasurer, Josh Frydenburg.
Of course, as the adage goes ‘nothing goes up in a straight line’. As with the resultant economic challenges, bringing COVID-19 under control is likely to remain bumpy and uneven. One uncertainty (and there’s a lot of uncertainty) is the effect that different strains of COVID will have on the global recovery. Fortunately, there’s cause to be optimistic.
Even with limited genomic sequencing, over 400,000 variants of the virus have already been catalogued. This is normal as with every transmission you have the chance of mutation, most of which make very little difference to infection and mortality rates. Occasionally though, a mutation or combination of mutations in most cases align, risking a change that threatens our best efforts. At present there are three identified variants that concern medical professionals; the UK strain, the South Africa strain and the Brazil strain – with more emerging.
Scientists have identified that many of the same mutations have occurred at the same time (in very different locations), suggesting something called ‘convergent evolution’. In simple terms, this submits that the strains may become more similar over time, rather than less. If this is the case, then it is good news for the ongoing effectiveness of current vaccines and keeping economies growing.
The vaccine’s effect on inflation
An important question we hear from investors is how will the vaccine rollout affect inflation? With more government stimulus in the pipeline – particularly the US$1.9 trillion (A$2.5tn) relief package currently passing through US Congress – combining with a surge in savings from societies which have spent considerable time in lockdown over the last 12 months, Australia’s 10-year bond yield is back above its pre-pandemic level, while the US also hit one-year highs in late February.
This recent spike in interest rates indicates an expectation of higher inflation in the medium term.
The difficultly in predicting inflation is demonstrated by two financial heavyweights Janet Yellen, former chair of the Federal Reserve and Larry Summers, Barack Obama’s former economic adviser, who have taken opposite positions on the near-term future of inflation – and subsequently interest rates. Summers predicts the sheer size of the US government stimulus at a time when COVID-19 cases are dropping rapidly will set off huge inflationary pressure. Yellen, on the other hand, said that unemployment is still so high, the stimulus is warranted.
In Australia, the RBA has said it expects interest rates to stay unchanged at an official rate of 0.10% until “at least” 2024. Bond markets suggest that inflationary pressures may force interest rates higher as early as 2022, though other explanations can be offered.
The expectation of higher interest rates driven by a surging economy is reflected in the stock market. Investors are focusing more on cyclical stocks, such as financials, who benefit from higher interest rates and periods of rapid growth. From 1 January 2021 to early March, the S&P/ASX 200 Financials (XFJ) has risen around 600 points or 11%. Over the same time, technology stocks – 2020’s market darlings – represented by the S&P/ASX All Technology Index (XTX) has fallen 5%.
Of course, what is unknown, both in Australia and the US, is how central banks will respond. The RBA and the Fed are likely to step in with large bond purchases to drive down yields (and increase prices) once again, though are yet to do so.
Another factor is the planned end of JobKeeper in late March. The government has hinted that JobKeeper will extend past this deadline, at least for the tourist and retail sectors. Any further action by the government to support parts of the economy will smooth out a bumpy weaning off government support for businesses.
It’s time to be (cautiously) optimistic for the economy
So, just as the health crisis brought about the economic crisis, the accelerating march to herd immunity heralds an altogether more constructive business environment. This combines to provide, in the RBA’s words, “better prospects for a sustained recovery than there were a few months ago”2. Whilst this remains “dependent on the health situation and on significant fiscal and monetary support”3 it has the full attention of those people and institutions who are crucial to meet the challenge.
Looking forward there is an expectation of a continued though uneven and even bumpy recovery.
Published by Andrew Garrett, National Investment Specialist, Perpetual Private