Market Scenarios and Risks - April 2021

Monthly update

Significant progress in managing the pandemic, massive fiscal impulse in the US, and boosters in the RoW amidst accommodative monetary policies. All these call for a rebalancing of the probabilities assigned to our scenarios. We are raising the probability of our upside case from 10% to 20% and lowering the probability of our downside scenario from 15% to 10%. We have lowered the probability of our central scenario, which assumes improving growth and a contained inflation trajectory, from 75% to 70%. In this scenario, equities outperform on the back of abundant liquidity and improving fundamentals, while higher US bond yields and slow vaccine rollout in the EU pose tangible risks.

Monthly update

Risks are clustered to ease the detection of hedging strategies, but they are obviously linked. We have amended the overall narrative and change the probabilities of risks in light of recent developments and changes in our central & alternative scenarios.

1. Growth narrative taking the lead corroborates the “risk-on” stance across assets

• In the US, significant progress in pandemic management, massive fiscal impulse and huge household savings are underpinning the growth dynamic and should lead to a DM economic recovery.
• We have revised our UST 10y 12-month yield range forecast to 1.8%-2% (from 1.5-1.8%).
• The Eurozone is lagging behind, as lockdown measures limit the recovery, and we expect a decoupling of US vs. Eurozone economic growth. The ECB will therefore maintain easy financial conditions.
• The rebound in Eurozone corporate earnings growth is not fully priced in by the markets, while interest rate expectations are unlikely to move higher. The value/cyclical features of EU equity markets confirms our preference for European equities.
• We expect the economic growth premium between EM and DM to narrow, suggesting a more cautious and country specific exposure to EM equities

2. Rates moving towards a higher regime as growth outlook materially improves: volatility and speed are a key risk, with global spillovers via tightening financial conditions

• The expected ranges call for a contained steepening in the UST 10-30 year section.
• As the long-end of the yield curve is already a source of risk for institutional investors’ P&L, we believe that the Fed will be vigilant and prevent a strong rise in UST 30y yields and avoid the negative snowballing effects across asset classes.
• The rise in 10y real yields will be nevertheless be limited by the FAIT (Federal Reserve Average Inflation Targeting) framework, which anchors 5Y real rates, as the Fed commits to raise rates only when Core PCE is sustainably above 2%
• The reaction of EM Fixed Income and FX to higher UST yields has been heterogeneous and smoothed by the broader “risk-on” environment.
• The rebound in the US dollar and US interest rates are not yet sufficient to alter our broad preference for EM vs. DM.

3. USD: Short-term bull, medium-term dull

• The USD appreciated vs low-yielding FX, while commodity currencies are still outperforming the greenback.
• As US inflation expectations start to drift lower while real rates are holding up, we expect a strengthening of the USD trend vs the entire G10 spectrum.
• We have revised our EUR-USD targets accordingly: short-term to stay in the current (1.16 to 1.18), and returning to its depreciation trend in the medium term (towards 1.24)

4. Turkey: unexpected change at the CBRT

• After a few months of orthodox MP (+875bps of tightening since November 2020), the governor of the Central Bank of the Republic of Turkey (CBRT) was sacked the same week he raised the policy rates by 200bps to 19%.
• That decision has triggered some turmoil on the Turkish assets and a sudden repricing of MP expectations for the months to come. CBRT is now expected to cut its policy rates earlier and by more than expected. While inflation should moderate by the end of 2021, in the next months it is expected to climb up to 18% YoY.
• The market has considered the event an idiosyncratic incident with only a brief impact on EM asset classes.

Covid-19 situation update by Pierre BLANCHET, Head of Investment Intelligence Fifteen months after the virus left China, the WHO has registered 128 million confirmed cases and 2.8 million deaths. Nearly 80% of registered contaminations are in Europe and the Americas. Despite being the most populated continent, Asia has not recorded more than 15 million cases overall. Since there is still no treatment, mass vaccination to reach herd immunity and social restrictions are the only solutions available. A total of 520 million vaccine doses have been administered so far, with 140 million doses in the US alone. The number of available vaccines is rising. Europe granted approval for the J&J vaccine in March. Novavax (US) and CureVac (Germany mRNA vaccine candidate) are in late-stage trials and may be approved in the coming weeks. Pharma companies distributing available vaccine are now working on boosters, next-gen vaccines and paediatric trials. The AstraZeneca/Oxford vaccine, mainly used in Europe, has been paused several times and its efficacy has been revised downward. An effective therapy has yet to be found. GSK & Vir are trialling an antibody therapy, which is showing an 85% decline in hospitalisation or death vs a placebo.