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Economy: Will delta stop the turbo cycle?

A wave of economic growth is travelling around the world like a locomotive. In Europe, momentum has yet to reach its peak. But uncertainty in connection with COVID-19 variants is looming over the recovery like a dark cloud. What does this mean for the investment strategy?

The capital markets have already priced in a substantial economic rebound. That seems perfectly reasonable: There has been a clear trend of economic activity picking up sharply wherever countries have been easing their COVID-19 containment measures. Like a locomotive, the recovery is making its way around the world. It first left the station in China, where the rapid implementation of a rigorous containment regime meant that restrictions could be rolled back again relatively soon, paving the way for a V-shaped recovery. It then moved on to the US and is now reaching the eurozone and various emerging markets.

More than 3.5 billion doses administered worldwide

No. of vaccinations per country/region (million doses)

More than 3.5 billion doses administered worldwide
Sources: Our World in Data, Union Investment, as at 15 July 2021.

A notable feature of the economic reopening has been a steep and rapid bounce-back accompanied by various bottleneck effects, which are caused by supply normalising at a slower rate than demand. In addition, the combination of government stimulus programmes, pent-up demand for consumer goods and capital goods, and favourable financing conditions is providing a strong tailwind for the global economy. The early-cycle phase is therefore shorter than in a normal economic cycle, creating a kind of turbo cycle. At the same time, the inflation picture is being somewhat distorted. But what happens next?

In contrast to the last cycle, which was drawn-out and flat, we could now be entering a long and steep(er) cycle. It seems very conceivable that the economic recovery could put the global economy on an above-average growth path. After all, short-term income replacement policies during the crisis were followed by government-backed stimulus and investment initiatives in the three biggest economies – China, the US and the eurozone. These measures are designed not just to shore up demand but to boost it.

This shift in the fiscal policy approach of governments towards a stronger stimulation of growth could kick-start a longer-than-usual and very robust economic cycle that would be positive for the capital markets. The US is seizing the opportunity presented by this crisis to drive forward a structural transformation. Fiscal stimulus measures in Europe are smaller in overall scale, but the Next Generation EU (NGEU) initiative is providing a framework for future-oriented investment at supranational level in addition to the measures taken by individual countries. Whether Europe will go down in history as having pulled out all the stops or merely as making half-hearted attempts will depend on how the individual member states use the available funding.

Limited impact from spread of the delta variant

At present, the short-term outlook is a mixed bag. Different regions and sectors are at very different stages of recovery. The industrial sector has already bounced back strongly and many industries are now enjoying a boom. In the service sector, which had been – and in some cases still is – much more affected by coronavirus-related restrictions, the recovery is taking longer to get off the ground. And the spread of new coronavirus mutations such as the delta variant is creating heightened uncertainty.

Consequently, concerns about a ‘delta dip’ recently caused some nervous tension in the capital markets. Any further spread of the variant could weigh on certain sectors such as tourism, hospitality and air travel, but overall, variants should have little to no impact on the continued economic upturn – provided that no variants emerge that are resistant to existing vaccines.

Delta variant negligible as an economic risk factor (UK case study)

Daily cases, no. of deaths more significant than no. of cases

Delta variant negligible as an economic risk factor (UK case study)
Source: Bloomberg, as at 13 July 2021.

The currently approved vaccines are effective against all mutations that have been identified so far. The impact of further waves of infection should also be limited, because decisions on potential new containment measures would be guided not only by the number of infections, but also, crucially, by the rate of hospital admissions and intensive care capacity in hospitals – neither of which are currently at critical levels. Another factor is that the vast majority of people in high-risk groups, such as the elderly and those with underlying health conditions, have now been fully vaccinated. However, in the short term, regional and sectoral differences in the trajectory of the pandemic could still have an impact and cause price volatility. The picture in the emerging markets is even murkier due to factors such as slower progress with vaccination programmes. Nonetheless, we can see signs of a broad-based recovery here too.

Impact of the pandemic is waning

Decisive medium- and long-term metrics for investors include not only infection rates, immunisation levels and economic growth but also the outlook regarding fiscal and monetary policy measures. At present, it seems most likely that economic activity will continue to normalise and that the further course of the pandemic will have only a limited influence on price movements in the capital markets.

Union Investment’s experts anticipate economic growth at a rate of 6.7 per cent in the US and 5.1 per cent in the eurozone in 2021, followed by growth of 4.2 per cent (US) and 5.0 per cent (eurozone) in 2022. Momentum in the eurozone should remain a bit higher because the region is at a slightly earlier stage of the cycle. Based on the latest economic data, the German economy is leading the field in the region.

Economic growth in Europe is still picking up

Comparison of purchasing managers’ indices for the manufacturing sector

Economic growth in Europe is still picking up
Source: Bloomberg, as at 13 July 2021.

Economic output in China and the US has returned to or even risen above pre-coronavirus levels. However, China is already seeing a slowdown in the pace of growth and the US is likely to see a slight dip in its Q3 growth rate compared with the second quarter. Indicators such as the US purchasing managers’ indices reflect this trend but are currently still at very high levels. US consumers also remain in an upbeat mood. Overall, it seems that growth is shifting down a gear.

Risk assets remain well supported

With regard to the investment strategy, all of this means that risk assets such as equities and commodities should remain well supported because fiscal and monetary policy measures in the eurozone and the US continue to be geared towards stimulating growth. Union Investment’s experts regard the risk of inflation as generally manageable and a largely temporary phenomenon.

The central banks are not expected to tighten the reins much. In the US, tapering measures – i.e. a reduction of the Federal Reserve’s bond purchases – will probably begin in the second quarter of 2022 at the latest. The first hike of the Fed’s base rate is likely to follow in the first half of 2023. In the eurozone, the ECB is not expected to change its current monetary policy approach fundamentally, notwithstanding its strategic decision and the introduction of a symmetric inflation target. This means that the capital market rate will probably remain fairly low for some time, although not quite at its lowest level. In this expansionary monetary policy environment with ultra-low interest rates, upside potential in the eurozone bond market will remain meagre. However, Bund yields should pick up slightly as and when the ECB starts to gradually scale back its bond purchases.

Equities remain the preferred asset class, followed by commodities and corporate bonds. However, investors will have to adjust to a less favourable growth/policy mix. As discussions begin about potential tapering by the Fed and as growth in connection with the reopening of the economy eases off, prices of risk assets will flatten out somewhat and their lead over government bonds will melt away. In this environment, tactical allocation and active asset management are gaining in importance.


As at 15 July 2021