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An Election of Consequence and the Post-COVID Year

SARAH HEWIN, HEAD OF RESEARCH, EUROPE AND AMERICAS
STEVE ENGLANDER, MANAGING DIRECTOR, GLOBAL HEAD OF G10 FX RESEARCH

The news of Joe Biden’s election victory followed rapidly by announcements of multiple COVID-19 vaccines heralds a brighter year in 2021. Global investors are looking ahead with greater confidence, both in the likely impact of vaccines on financial and commodity markets around the world, and in how Biden’s foreign policy agenda – likely to be bolstered by newly gained Democratic seats in the Senate – could influence market sentiment and global trade, particularly in emerging markets.

A catalyst for growth

Multiple vaccine rollouts starting in the first half of 2021 have boosted market sentiment and look set to be powerful drivers of global growth. We expect global GDP growth to bounce back to 4.8% in 2021 from a 3.8% contraction in 2020. However, the positive growth impact will probably not fully close the output gap created by the COVID crisis, and is unlikely to be fully felt until the second half of 2021. Global growth could normalize to 4.0% in 2022, but this would be largely a function of closing the output gap from 2020. Central banks around the world are likely to maintain accommodative policies until growth recovers on a more sustained basis.

A boost to global trade…

We expect global trade to improve in 2021, with recovery led by China and India. Global trade took more than two years to recover after the 2008-09 global financial crisis; in contrast, export volumes have already rebounded from the lows of Q2-2020 and are close to end of 2019 levels. Export volumes should pick up further in 2021 as global demand returns, particularly during the second half of the year.

The return to a more predictable and collaborative approach to foreign policy under Biden’s presidency should also benefit export-oriented economies in 2021, particularly in Asia, which suffered the effects of the US-China trade war in 2018-19. The recent signing of the Regional Comprehensive Economic Partnership (RCEP), an Asia-wide free trade agreement, is a positive sign of the region’s willingness to maintain open trade flows.

…helps make emerging market assets attractive

With the global economic recovery led by improved emerging-market (EM) trade, EM local currency-denominated debt, credit and FX will likely become increasingly attractive as risk premia decline further and historically low bond yields in developed markets encourage the re-allocation of capital. At the peak of the COVID crisis, roughly USD 1.2tn was held “on the side lines,” in cash and risk-free securities. We believe that USD 800bn of this capital is ripe for reallocation to higher-yielding assets.

This reallocation of capital to emerging markets is already taking place in some markets, particularly China, with China government bonds (CGB) one of the few major bond markets to see yields rise in 2020. With the Chinese yuan (CNY) one of the best-performing emerging market currencies during the year, the historically wide CGB spread is likely to remain attractive compared with flat or negative yields elsewhere. Other markets, such as in Korea and South Africa, have seen significant foreign inflows since the US election as investors dash for yield. Countries such as India and Indonesia also offer significant opportunity, offering the best total-return prospects for the year ahead. EM currencies are well-positioned, and just as Asia is leading the recovery in EM local-currency debt markets, Asia (ex-Japan) FX is likely to perform well in 2021. We think the Mexican peso (MXN) and South African rand (ZAR) should benefit from the search for yield and improved prospects for global trade.

A bounce-back in commodities

The recovery from the COVID-19 crisis will probably require an aggressive combination of fiscal and monetary stimulus, with extremely loose government and central bank policies, to avoid an economic relapse. Such a stimulus-fuelled recovery should support the emerging recovery in commodity markets, as well as fuel broader re-allocation towards emerging markets.

The news of COVID-19 vaccines, which could herald the return of travel and tourism, will come as particularly welcome news to the oil-producing nations of the Middle East. These economies had not yet recovered from the 2014 oil price shock when the pandemic struck; previous predictions were that average global oil demand could recover less than 60% of its 2020 loss in 2021. We see upside risks to oil prices should the recovery be stronger than expected. Likewise, a weak US dollar, increased asset allocation to commodities, a faster-than-expected fall in US shale oil output, the continuation of production curbs, and slow or limited progress on the reopening of dialogue between the US and Iran could add to upward pressure on oil prices.

While 2021 looks set to be the year when the post-COVID vision could be within reach, there are lingering risks to economic recovery, particularly in the short term, given high infection rates in the US and Europe, the challenges of delivering the vaccine on a mass scale, and the lack of a stimulus package in the US. These risks will likely keep pressure on central banks to maintain, or even expand, their accommodative monetary policies.

Read more about the impact of COVID-19 in organizations across Europe and the Americas in our client survey.

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