As of this writing, the US is one of only six countries in which more than 50% of the population has received at least one dose of the COVID-19 vaccine. Less than 25% of the global population is in the same category. Developed economies have outperformed emerging economies in this regard. Regionally, North America and Western Europe have made better progress than Eastern Europe, Asia, Africa, and Latin America. Such disparities will affect recovery of international travel and trade of certain goods. Additionally, “herd immunity” remains elusive because of the spread of variants. For these reasons, we believe there will be a strong positive correlation between restoration of domestic economic capacity and acquired immunity to the coronavirus.
Economic data continue to support an outlook of accelerating activity associated primarily with pent-up demand. In several industries, shortages of both materials and available labor have resulted in price surges. We expect elevated prices in certain sectors will gradually decline as supply is increased to meet higher demand levels. Market indicators suggest inflation has already begun to moderate. Despite concerns over inflation, we maintain the view that the Federal Reserve will not adjust monetary policy in 2021.
During the most recent Fed meeting, the policy committee adopted a more hawkish stance. On balance, investors should view the change in posture as a net positive because the Fed essentially expressed confidence in a sustained post-pandemic economic recovery. The FOMC acknowledged that emergency measures implemented during a period of maximum uncertainty were no longer necessary. Otherwise, they reiterated the view that inflation should prove transitory and reinforced its commitment to restore full employment.
The Fed will implement a change in monetary policy in two successive programmatic shifts. First, the Fed will gradually reduce liquidity support for the markets (i.e., quantitative easing). Second, the Fed will contract the money supply (i.e., increase in the Fed Funds target rate). Thus, likely at some point within the next two years, the financial markets will confront a policy transition that could manifest in heightened volatility.
In August 2013, as global economies emerged from the Great Financial Crisis, the Fed’s policy transition resulted in stock market volatility. Additionally, 10-year Treasury yields rose to 3.0% by year end 2013. The 10-year Treasury yield subsequently peaked in early January 2014 and fell to a low of 1.7% in February 2015. The Fed’s experience in the 2013 – 2014 period likely serves as a template for the current Fed as it navigates the transition away from emergency liquidity support and expansive monetary policy. Given historical experience, it is possible, therefore, that 10-year Treasury yields could peak this cycle at levels lower than in 2013.