Spring economic outlook shows above-consensus base case clouded by inflation concerns and pandemic uncertainty
After passing the one-year milestone of the COVID-19 pandemic, the world is poised for a strong economic rebound, said RBC Global Asset Management (RBC GAM) in its latest global investment outlook report for spring.
“The pandemic is entering a new phase with vaccines at hand, case counts in decline and businesses gradually resuming normal operations,” wrote Investment Strategist Eric Savoie and Chief Investment Officer Daniel Chornous. “Bond yields have surged, stocks have climbed to records and a variety of market signals suggest that economies are on the cusp of a strong recovery.”
Savoie and Chornous pointed to a number of constructive developments across major nations. Tightened restrictions and vaccinations have contributed to a worldwide plunge in new infections and transmission rates, helped further by seasonal factors. That COVID-19 containment has set the stage for a global economic recovery, which has plenty of room to run as it’s supported by significant monetary and fiscal stimulus.
“We look for a significant rebound in economic growth this year, with most economies achieving pre-pandemic levels of output sometime this year or next,” they said, noting that their economic forecasts have been mostly upgraded for this quarter and remain above the consensus.
While their base case scenario is fairly optimistic, the two acknowledged that the pandemic’s unprecedented impact, uncertainties surrounding the distribution of vaccines, and the emergence of new variants as wild cards that “make the growth outlook less clear than usual.” Other uncertainties were also present with respect to potential inflation and the amount of additional fiscal stimulus that will be deployed.
“The vaccine and the virus represent greater downside risks, but the reverse is true regarding fiscal support,” they said.
With respect to inflation, they pointed to escalating concerns among investors as easy monetary policies, looser targeting among central banks, and historical levels of sovereign debt come into play. The reality is that prices are on the rise, though they are coming off a low base; as Savoie and Chornous noted, expectations remain in line with levels seen over the past decade.
“It’s also worth keeping in mind that demographics and sector effects related to technology, health care and education are putting downward pressure on inflation,” they said.
Investors’ expectations of hotter inflation are offsetting central banks’ efforts to contain interest rates, leading to a surge in longer-term bond yields. The U.S. 10-year Treasury, they noted, passed 1.50% for the first time since the pandemic, partly due to after-inflation interest rates rising from unsustainably low levels. But they maintained that structural demographic changes, a growing preference for saving over spending, and the maturing of emerging markets will put a ceiling on that ascent in time.
“Moreover, the recent surge in global yields has dampened the acute valuation risk that existed in the bond market and we think that bond prices could find near-term support at current levels,” they said.
Although valuations in certain areas of the stock market are elevated, Savoie and Chornous said their modelling indicates price-to-earnings ratios could rise even further as pandemic fears fade and interest rates normalize.
“While U.S. large-cap technology and momentum stocks are expensive, equity markets in Canada, the U.K., Europe and Japan remain below their fair values and offer compelling upside,” they said.