An economic boom under supervision and a benevolent Fed - Dorval's Macro Corner (April 2021)

"Adapting economic knowledge to market realities and breaking free from the tyranny of indices"
François-Xavier Chauchat
Member of the Investment Committee, economist and strategist.

Global financial markets are entering a new phase marked by the realization of the long-awaited economic boom, first in the USA and in the U-K., then in Europe within a few weeks. Whether at the macro or micro level, the breadth of the recovery will be closely monitored. Emerging countries (excluding China) have been weakened by the Covid crisis, and some are already forced to raise interest rates (Brazil). As for the sectors most affected by the epidemic, which will reopen gradually, they need visibility that vaccine news sometimes undermine. For these reasons, the rise in equity markets has been narrower since early March, and star stocks (FANGs, luxury goods, etc.) have played a role of safe haven. We believe this is likely temporary, as the virus's diminishing grip on our economies remains the main story.

 
For its part, the Federal Reserve will pay particular attention to the diffusion of the economic recovery to the job market. A decline in the unemployment rate will not be enough. The Fed is aiming for a vigorous, deep and lasting recovery in the labor market. It wants to learn from the pre-Covid experience, when what looked like full employment—an unemployment rate of 3.5%– didn't prevent inflation from staying below target. The Fed wants a much higher level of labor market participation before it starts talking about raising interest rates.

 
The Fed's benevolence carries a strong and positive message for the economy and financial markets. However, Jerome Powell wants to avoid creating the conditions for a future bond tantrum similar to that of May 2013, when Ben Bernanke had announced a surprise reduction in the Fed’s asset purchases. The Fed is preparing the markets for this next step this time around, although it is not yet relevant. Its attitude favors the scenario of a gradual rise in long-term real rates by the end of the year.

 
The Fed’s reach for true full employment is necessarily well received by an American administration that has adopted a narrative in radical departure from previous decades - but in tune with global trends. Joe Biden has environmental and social ambitions that could have a significant impact on Corporate America: higher taxes, minimum wage, re-unionization, etc.. Investors are currently more sensitive to the positive stimulus message than to the risks for companies, especially as these risks are difficult to quantify. In our opinion, however, this background reinforces the importance of the corporate governance dimension as a selection criterion. Good governance should indeed make it possible to better manage the volatility of the regulatory, fiscal and societal environment. In our international funds, a diversified basket stocks best reflecting our SRI requirements aims at meeting this challenge.

 

Download Dorval’s Macro Corner of April 2021 in PDF version here

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