Macro Matters July 2021

(Source: Merlea Macro Matters)


The global economic recovery roared ahead in the second quarter as economic reopening and growing vaccine coverage paved the way for another large step toward normalisation. With 2.5 billion vaccine doses now administered worldwide as of mid-June, covering about 21% of the total global population, and the share of people with at least one dose approaching or exceeding 50% in the United States and several other developed markets, signs the pandemic is coming to an end can be seen across mobility and economic indicators in various regions—alleviating concerns that consumer behaviour and economic activity would be permanently altered from the crisis. People are inherently social beings, and after over a year of various social distancing restrictions, they are proving eager to return to normal life.

Optimism and consumer confidence have rebounded sharply, with a sustained global recovery now the baseline expectation—the International Monetary Fund (IMF), for example, upgraded its growth projections once again for 2021 and 2022 to 6.0% and 4.4%, respectively, following increases in October and January.

The strongly rising stock market since 1989 has been accompanied by consistently falling interest rates.
It is evidence of the valuation tailwind that low rates give share prices.

 Uncertainty remains, though, as the pace of economic recovery is diverging between those countries that have been able to bring infections under control, have accelerated vaccination campaigns, and have supported the economy with ample amounts of liquidity via exceptionally loose fiscal and monetary policy, and those that continue to lag. New virus variants and a resurgence of coronavirus cases in certain countries, notably India, have also led to growing concerns by some segments of the population that reopening efforts may prove to be premature hindering the full economic recovery in some countries, sectors and industries. Certain countries also continue to keep restrictions in place despite the improving pandemic situation, such as the United Kingdom—which already has one of the world’s furthest advanced vaccination programmes and has dramatically reduced hospitalisations and deaths over the past several months. Policymakers worldwide face the difficult challenge of determining when, and in what form, they can return to pre-COVID life.

Shakier Monetary Policy Outlook

While monetary policy will undoubtedly remain accommodative over the near term, there are signs that policymakers are growing more concerned about the potential inflationary impact of the unprecedented onslaught of policy stimulus since the crisis began. Despite (a now weakening) consensus that inflation will be transitory, sharply rising prices are putting pressure on fiscal and monetary authorities to adjust policy to prevent economic overheating. Conversely, with markets largely priced to perfection, a shift in policy stance could result in significant volatility—a result central bankers are hoping to avoid.

Inflation pressures are rising globally as economic normalisation has spurred a consumption-led recovery. Supply bottlenecks, rising commodity and input prices, labour shortages and wage increases, an ever-growing stockpile of excess savings, ultra-low borrowing costs, and massive fiscal stimulus are all contributing to a rapid increase in inflation. While we do not believe inflation will get out of hand, it will be difficult to keep subdued as prices continue to rise and policymakers maintain a very loose policy stance. The US Federal Reserve in its June policy meeting acknowledged inflation risks are now skewed to the upside. Rising inflation may force central banks to tighten monetary policy faster than market expectations to rein in prices.

Rich Valuations Are Increasingly a Concern

Markets have been moving well in advance of economic data points, both on the way down and during the recovery. Correspondingly, many risk assets have rebounded sharply, and some are now trading tighter than pre-COVID levels, with some sectors trading at or near all-time historically tight valuations, propelled by prolonged massive monetary easing. However, tight valuations in some segments, markets pricing in a strong profit recovery, and P/Es that are above historical trends indicate some complacency. On the Fed’s side, the evolution of the US labour market and strength of the economy should decide the timing of tapering, even though inflation numbers continue to surprise. We believe the Fed will wait for a string of strong employment numbers before discussing tapering in the summer or later this year, although in the June meeting the tone has become more hawkish. In this environment, investors should remain neutral towards risk assets.


Bond markets overall have been relatively resilient in the face of the onslaught of rising inflation data. This partly reflects the market’s confidence in these inflation moves being transitory and may also partly reflect the lingering doubt over the ability of alternative scenarios of higher inflation coming to fruition. Nonetheless, given the current market levels, risks for bond investors clearly skew to the downside. The base case of transitory inflation looks mostly priced in, while the upside inflation scenario would lead to some significant repricing of inflation risks. We continue to see the potential for a further above consensus rise in yields, and limiting duration remains one of our main underlying strategy themes. We retain a slightly optimistic outlook on risk assets given the potential for a further steepening of the yield curve and continue to favour shorter duration and floating rate fixed income assets with relatively less sensitivity to rising rates. We expect the remainder of 2021 will be challenging. Returns will be harder to come by, but should still be positive, in our view. Overall, we are positive on corporate credit, especially the shorter end of the curve.

The uncertainty around inflation expectations is likely to be a reoccurring concern for investors as more data becomes available in the coming months. For investors who do not have the risk appetite, supplementing your traditional bond allocation with alternative diversifies may be prudent. Traditional core bond exposures can help to balance equities in the case of a growth shock, but they are vulnerable to exacerbating portfolio losses in the case of an inflation surprise. A complementary allocation to more defensive-oriented alternatives with less inflation vulnerability may help to better balance equity portfolios if the economy shows signs of overheating and inflation proves not to be transitory.

Listed Property

Record government stimulus, monetary policy easing and the roll-out of vaccination programs are now intersecting with the gradual lifting of lockdown restrictions.

These forces are feeding rising inflation expectations, expressed through a sharp increase in nominal bond yields. Last November, the Australian 10-year nominal government bond yield moved through 0.80%. Since then, it has taken just four short months to pierce a high of 1.90%, settling at around 1.50 % more recently. This is important because the government bond yield, or risk-free-rate as it is sometimes known, is a reference for the theoretical valuation of all manner of financial assets but especially ‘bond proxies’ like AREITs. The theory is that as the risk-free rate rises, returns from assets like AREITs falls. That has certainly been the case in Australia of late. With investors moving out of cash and listed bond proxies into more cyclical opportunities. It’s easy to consider rises in bond yields and deduce that “bond proxies” like AREITs will underperform as inflation expectations rise but it’s not that simple. Even if higher inflationary expectations become a reality, in my view the prospects for future AREIT returns remain positive.

Investors can expect an income yield of approximately 4.1% in FY22, based on current pricing levels, with this income backed by contractual income obligations.

There are two reasons for this. First, a sustainable rise in general pricing levels and economic growth should be welcomed. Governments and central banks the world over have been working to engineer this for over a decade. It is odd that this imminent prospect is now a source of concern. Weak wages and economic growth have bedevilled the world for years. If the return of inflation heralds the end of these two things, income investors should be relieved rather than worried.

Second, the best protection against actual inflation (not just the expectation of it) is to invest in real assets. Commercial property leases typically include annual rent escalations equivalent to or above the consumer price index, or a fixed percentage of annual rent, often above the prevailing rate of inflation. Commercial property rents have in-built inflation protection. A similar argument applies to capital values. Because asset revaluations incorporate consideration of replacement costs, rising inputs costs through higher material and labour charges are ultimately incorporated into asset revaluations.

Australian Equities

Most analysts and economists agree, the key threat to the market is if inflation (or general price rises) suddenly spikes higher. That would force central banks to raise interest rates and that, they say, would send the share market into a tailspin. To date, sluggish wage growth has all but put a lid on inflation. However, if the Treasurer has his way and the Reserve Bank’s forecast proves correct, an unemployment rate going well below 5 per cent could begin to stoke inflation as wages gradually rise. It’s actually a bit puzzling at the moment. You have hundreds of billions of dollars of stimulus, record low interest rates, and yet inflation is still basically non-existent. But there are also obvious signs of market euphoria, which are often followed by market corrections. A clear warning signal is the record amount of initial public offerings on the exchange.

Economists argue fundamental flaws in Australia’s industrial relations framework contribute to sluggish wage growth, but elevated levels of household saving may also be a factor.  From a mathematical point of view, the market’s price/earnings multiple (as a measure of how stock prices compare to the profits companies are making) is currently sitting at roughly 19x. That’s historically high. The reality is the market could go anywhere from here. For what it’s worth, those already invested are cautiously optimistic it will push higher from here in the short term.  Given the enormous recent run-up in share prices, however, and the unprecedented amount of stimulus behind it, when stock markets do fall, which they eventually will, it’s likely to be quite dramatic. Despite the recent volatility, there are some decent opportunities for investors.

In my view we are currently in the economic mid cycle, this part of the cycle tends to be longer than any other stage and is also when most market corrections have historically taken place. Investors may want to consider keeping sector bets to a minimum while employing other approaches to seek opportunities.  With Growth slowing and the economy beginning to appear overheated as inflation climbs higher, stock prices begin to look high compared to earnings. The best sectors to rotate into during this phase include energy, utilities, healthcare, and consumer staples. The main reason these sectors do well is that their revenues are tied to basic needs.

Global markets


As the U.S. heads into the summer, the economy is sizzling. A better vaccination outlook, a faster reopening schedule, and $2.8 trillion from two stimulus packages have turbo-charged the U.S. economic recovery this year and the next, with supply constraints (businesses unable to make products fast enough to meet surging demand) preventing the economy from swelling at an even faster pace. Despite the improved outlook, the labour market still has a long way to go before it recovers the ground lost from COVID-19. The recovery in U.S. jobs growth remains soft, despite recent job gains, and the labour market is 7.6 million jobs short of the pre-pandemic peak. Inflation pressure is rising more than expected on the back of the strong rebound. Through May, the headline U.S. CPI has grown 5.0% year over year, the core index has risen 3.6%, and the PCE index–the Fed’s preferred measure–has grown 3.9%. Sequential measures of inflation are significantly higher.

The risk is that inflation will stay higher and last longer than the current forecast and could force the Fed to move earlier than planned, and earlier than what is currently priced by markets. The resulting repricing could cause market volatility, including widening spreads and diminished market access for higher-risk borrowers, and asset price volatility and downward adjustments, with knock-on effects on spending and, ultimately, employment and growth. The Fed is gearing up to taper, and yes, the median dot now has two hikes in 2023. But this is not terribly different from market pricing. Chair Powell noted in the June press conference that investors would get ‘a lot of notice’ on tapering. This is the opposite of the abrupt and short tapering that can upset risk markets. While I do not expect a taper tantrum, I simply do not see value at current rates. A grind higher – in both equities and bond yields – seems the most likely outcome for the next three months.


The euro area is finally hitting its stride. The economy has adjusted to restrictions, and high-frequency data points to a strong bounce-back entering Q3. With the hospitality and tourism sectors being allowed fully to reopen in the summer, I would expect a surge in consumer spending, supported by pent-up demand and accumulated excess savings. After a poor start, the EU has also made impressive progress on vaccinations and has now given as many shots as the US (315m as of June 17), with 46% of its population (and a greater share of the adult population) having had at least one.

Growth momentum should also be retained in early 2022, thanks to support from fiscal policies at the national and EU level. The European recovery plan (NGEU) has been fully ratified, and the European Commission raised €20bn through a 10-year NGEU bond issuance (the largest ever in Europe) to finance the first transfers to member states, which could occur just before the August summer break. The Commission has also started to approve a first batch of national recovery plans, which should be endorsed by the Council in July to unlock the funds. Against this backdrop, economist have revised their GDP growth forecast for the euro area higher and now expect 4.6% y/y this year and 4.4% next, recovering to pre-COVID levels of output by Q1 22. The ECB is even more optimistic and now expects pre-Covid GDP to be hit in Q4 21.

Even so, the central bank is likely to stay patient and accommodative for a long time. I expect the ECB to remain dovish, with the central bank committed to 2% inflation, willing to overlook a temporary overshoot should it occur, and likely to continue QE via the PEPP until March 2022 and via the APP beyond that. For the next few quarters at least, the euro area growth story looks in pretty good shape. Some investors are concerned that the European shares have already banked companies’ expected profit gains for the year, however, while others are fearful of sudden changes in US monetary policy that would affect all major global stock markets. As far as stock exchanges are concerned you get high degrees of correlation, so if the US falls it is hard to foresee a major decoupling.

United Kingdom

The Bank of England is unlikely to raise interest rates due to the higher inflation, as its target overshoot is likely to be temporary. While a re-opened economy could see rapid economic growth over the next two years, there is still a significant level of slack which would prevent higher inflation from taking hold. I would anticipate that the Bank of England will see through the temporary rise in inflation above its target and keep interest rates at current levels for approximately two years, to allow the economy to fully recover, and mitigate the downside risks to the outlook. The UK market is overweight the cyclical value sectors, such as materials and financials, that are benefiting from the post-pandemic reopening. Financials should also be boosted by the improvement in interest margins from steeper yield curve as the Bank of England (BOE) moves closer to lifting interest rates (although we don’t expect the BOE to move before the Fed).


Since the start of the year, Japan’s recovery has been put on pause by on-again-off-again declarations of emergency to try to contain virus flareups. Using narrowly selected restrictions on restaurants and bars to quell recent outbreaks but letting most other businesses carry on as normal. The approach has kept the economy from collapsing like it did last year, but it has also failed to stamp out the virus.  Japan’s economy shrank at a slower-than-initially reported pace in the first quarter, on smaller cuts to plant and equipment spending but the coronavirus pandemic still dealt a huge blow to overall demand. Separate data showed growth in bank lending slowed sharply in May, while real wages posted the biggest monthly jump in more than 10 years in April, in signs that the world’s third-largest economy was gradually overcoming last year’s pandemic hit. Among the mixed indicators are some reassuring signs for policymakers, who are worried Japan’s recovery will lag chief economies that have rolled out COVID-19 vaccines much quicker and are able to reopen faster. The revised gross domestic product (GDP) decline was mainly due to a smaller fall in public and capital spending, which both eased less than initially thought, offsetting a slightly larger fall in private consumption. Some analysts expect Japan’s economy to post another contraction in the current quarter – pushing it back into a technical recession – as an extension of coronavirus emergency curbs for Tokyo and other main areas hurts domestic demand. Disappointing earnings guidance for the current fiscal year and growing concerns about changes to US monetary policy are weighing on the market in the short run. I don’t see much upside expansion from the current level owing to the normalisation of the global economy coinciding with the hike of long-term interest rates.


Growth in China’s services sector slowed sharply in June to a 14-month low, weighed down by a resurgence of coronavirus cases in southern China, a private survey showed on Monday, adding to concerns the world’s second-largest economy may be starting to lose some momentum. The Caixin/Markit services purchasing managers’ index (PMI) fell to 50.3 in June, the lowest since April 2020 and down significantly from 55.1 in May. It held just above the 50-mark, which separates growth from contraction monthly. China’s official services gauge had also shown a marked slowdown in June, though it remained well in expansion territory. The private survey is believed to focus more on smaller companies.

Chinese equities have struggled over the last couple of months, in part due to increasing regulation on Chinese technology companies, and in particular their foray into financial services. Forecasting regulation measures is a difficult task, but my base assumption is that most of the regulation changes are behind us for now. Chinese equities have severely lagged the global market so far this year. The MSCI China Index has been broadly flat since January compared to a rise of around 13% on the MSCI Global Index.  It follows substantial outperformance of Chinese stocks last year when the MSCI China Index soared by approximately 28% compared to 16% on the MSCI Global Index.

Chinese stocks have been held back by a variety of factors in 2021, including the initiation of monetary tightening measures in China, credit stress, additional regulation, and continued cool relations with the US. One of the biggest contributors to the MSCI China benchmark is e-commerce giant Alibaba, which is down by around 10% since the start of the year. Overall, China appears well placed to outpace other global regions in the economic growth stakes, a factor that should provide some longer-term support for Chinese stocks.

Emerging markets

A bullish case is building for emerging-market stocks, which have trailed their developed-nation peers this year, with strategists saying the asset class is better positioned to benefit from a global reopening. There are already signs the gap is narrowing, with the MSCI Emerging Markets Index last month outperforming the MSCI World Index for the first time since January.

Relatively attractive valuations, a weaker dollar, and expectations that global supply chains will swing back into high gear are burnishing the appeal of developing-nation equities. The surge in global commodity prices is adding to optimism that improving growth will help boost cyclical shares in these markets. Rising inflation expectations and bond yields should drive continued investor rotation from growth to cyclical assets –- EM economies are more cyclical in nature.

Analysts from Blomberg see the MSCI EM index, which is trading at 14 times forward earnings, rallying about 20% over the next 12 months, according to data compiled by Bloomberg. That is almost double the advance seen for the developed nations’ gauge, which has a valuation multiple of about 20.  A successful vaccine rollout leading to a resumption of normalcy in the developed world and parts of EM – with that, comes optimism for corporate earnings and equity markets.

Risks include a vulnerability to escalating inflation, and a potential pullback in commodity prices, Investors looking for EM exposure may want to consider sticking to value stocks in Asia, particularly in China, India, and South Korea.


Gold price has weakened from $1916 to $1761 since the beginning of June 2021, and the current price stands around $1780. Gold remains under pressure amid concerns that the U.S. central bank might raise interest rates sooner than previously expected. Investors usually buy Gold to hedge against inflation, but currently, we had a different practice, and the focus remains on the dollar. The prospect of interest rate hikes positively influenced the U.S. dollar, and the most significant force behind the Gold price slide is the appreciation of the U.S. dollar.

Illustrates the relationship between the US dollar gold price and the real yield on a 10-year US Treasury Bond from 2003 to end of 2020.

Global business activity is recovering, and those whose interest it is to invest in precious metals like Gold should have the U.S. dollar on their “watch list.” On the other side, the global COVID-19 pandemic still poses downside risks to the recovery, and if the U.S. dollar loses its value in the upcoming days, it could help this precious metal to stabilise again above $1800 resistance.


Commodities are on a bull run, playing the triple themes of a recovering global economy, a weakening dollar and the possibility of an emerging super cycle. Oils joined in the rally with Brent trading back above US$70/bbl, up 40% this year. But the extraordinary turnaround in the oil price in the last 12 months also owes much to OPEC+ and its determined pursuit of market rebalancing. One risk to demand growth is Covid-19 and recurring lockdowns in some countries. New waves of the virus in India, Southeast Asia, parts of Europe and elsewhere were one reason why oil demand mildly undershot our initial expectations. Covid-19 still casts doubt over the pace of global economic recovery.

Also, growth in oil supply will be a fraction of expected demand growth in 2021. OPEC+ is exercising an abundance of caution to keep the market in balance and avoid surpluses as the economy recovers. Global liquids volumes will increase by just 1.3 million b/d this year, whereas we forecast demand to grow 5.9 million b/d year-on-year. Oil prices may have more upside in the coming months. I think Brent could exceed US$75 to US$76/bbl this summer with the prospect of a tighter Q3; trader sentiment is more bullish, some expecting US$100/bbl.

There is potential for a price squeeze with demand increasing and OPEC+ withholding its oil from the market. Much depends on the strategy of OPEC+, since these barrels can readily be put back into the market. Brent crude oil prices rallied to above $77 a barrel, the highest since 2018, on Monday 5th July, after ministers of the Organization of the Petroleum Exporting Countries and OPEC+, called off oil output talks and set no new date to resume them. Oil prices are at the highest since 2018 and have already prompted concerns inflation could derail a global recovery from the pandemic.

Sector 12 Month Forecast Economic and Political Predictions
AUD 0.76c – 0.80c The AUD has been especially volatile against the USD since hitting a three-year high in February 2021. AUD is a cyclical currency that should benefit from the global economic recovery later this year and the favourable interest rate differential with the US. However, tensions with China remain a downside risk, given the importance of China for Australia’s exports.
Gold $1,838 – $2,075


Globally, gold prices hovered near the key level of $1,900 an ounce due to a weaker dollar and lower bond yields.  The speculation that the Federal Reserve may bring forward the timeline for tapering bond purchases, especially after the upbeat US economic data has put downward pressure on gold. MCX gold has dropped and short-term momentum looks to be negative. Gold’s sharp up move in the last few weeks has made it vulnerable to profit taking which may extend further if the US dollar strengthens further.
Commodities WTIS US$70 – US$80


Base metal complex will benefit from easy money policy. Energy is the only undervalued sector.

Commodity prices continued their recovery in the first quarter of 2021 and are expected to remain close to current levels throughout the year, lifted by the global economic rebound and improved growth prospects. Global decarbonisation is good news for the metals sector, with mining being part of the solution rather than a problem due to its emission chain. Examples of metals that we like and are seeking exposure to in our investment strategy are copper, a universal beneficiary of electrification, and select battery raw materials such as nickel and potentially lithium (where supply is more readily increased).
Property This is a market for active stock-pickers. Record-low interest rates present a significant challenge for investors and their advisers seeking a healthy income yield, particularly for those depending on income from investments in retirement. With interest rates expected to remain “lower for longer”, Australian Real Estate Investment Trusts are well placed to generate reliable levels of income, with the potential for capital growth.
Australian Equities 6880 – 7650


This is a market for active stock-pickers.

Share prices are higher than “fair value”. The market’s price/earnings multiple (as a measure of how stock prices compare to the profits companies are making) is currently sitting at roughly 19 times. That is historically high.
Bonds 1.5% – 2.5%

Short duration warranted.

An inflation-linked bond fund might be a good addition if looking for more inflation protection.

The COVID-19 vaccine’s global rollout has coincided with rising bond yields, as investors anticipate higher inflation on the back of the expected post-pandemic recovery. The Australian 10-year bond rate will top 2 per cent by the end of the year, as the resolve of central banks to support their economies will come under more intense pressure.
Cash Rates On Hold Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.10%.
Global Markets
America S&P 500 3900 – 4300


Second quarter is likely the peak growth rate for both the economy and corporate earnings, with positive economic surprises waning. Inflation remains the key issue for the market, and inflation jitters are likely to keep the S&P 500 in a tight range until early July.
Europe European Index


After a slow start, the vaccine rollout is gaining pace and Europe should be on track for economic reopening by Q3. The post-lockdown recovery is likely to be extremely strong and GDP should bounce back by around 5% this year following last year’s near 7% decline. Europe’s exposure to financials and cyclically sensitive sectors such as industrials, materials and energy, and its small exposure to technology, give it the potential to outperform in the post-vaccine phase of the recovery when economic activity picks up and yield curves in Europe steepen.
Japan Hold The overall monetary policy framework is likely to be maintained for the time being. The central bank expects negative interest rates to be cut further only in emergencies, such as a sharp rise in the yen. Financial support measures for companies will expire in September 21, but financial conditions for accommodations, restaurants and other services remain tight. If the situation continues, the measures are likely to be extended.
Emerging markets Hold

Prefer Asia Emerging markets

Reports about COVID flare-ups and new lockdowns raise legitimate concerns about the near-term growth outlook in emerging markets. EM equities overall have been range bound over the past 13 years. Only recently has the MSCI Emerging Markets Index recovered to its peak levels in 2007. From a valuation perspective, emerging markets equities offer compelling valuations trading at 17.2 times the trailing price-to-earnings (P/E) ratio as compared with the MSCI All Country World Index (ACWI) at 24.5x.
China Accumulate Chinese stocks could struggle in the second quarter, as policymakers seek to rein in risky lending and the economic recovery from coronavirus accelerates elsewhere in the world. Beijing’s focus had shifted to normalising monetary policy after cutting interest rates during the health crisis, which could sap liquidity from markets in Shanghai and Shenzhen. Regulators’ recent crackdown on fintech and ecommerce companies such as Jack Ma’s Ant Group and Alibaba had also weighed on investor sentiment.



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