John Fahey: Taking stock of the Covid risks facing markets for the rest of the year
An uplift in activity occurred amid progress on the rollout of vaccination programmes, thereby allowing restrictions to be eased. File picture
Despite the impact from the Covid-19 pandemic, the first six months of 2021 from a global macro and markets viewpoint, while not without challenges, were generally encouraging. On the macro front, the majority of economic releases from the main economies tended to surprise to the upside of expectations.
One factor behind this was that these economies proved more resilient than had previously been envisaged, and were better able to adapt to the restrictions that were in place to contain the virus during the early part of 2021.
Meanwhile, as we progressed through the first two quarters, the underlying data over the period suggested an uplift in activity was starting to take hold.
This occurred amid progress on the rollout of vaccination programmes, thereby allowing restrictions to be eased. The economy was also supported by an accommodative policy environment, both from a fiscal and monetary stimulus perspective.
Meantime, we saw a strong performance from equity markets in the first half of the year. Risk appetite was buoyed by the prospects for a robust economic recovery amid the vaccine rollouts and the supportive policy backdrop provided by governments and central banks.
The main US equity indices recorded a number of new record highs, with the global benchmark S&P 500 index up by about 15% over the period.
On bond markets, although they have fallen considerably from their peaks in the last few weeks, yields reached the halfway point of 2021 a good degree higher than where they were at the start of the year.
This was against the improving macro backdrop and markets starting to anticipate rate hikes from the US Federal Reserve and the Bank of England from mid-2022, earlier than had previously been expected.
On commodity markets, oil staged a strong recovery on the back of the improving macro environment, and more recently amid uncertainty over future supply changes from the oil suppliers.
Currency-wise, the euro lost ground against the dollar and sterling. Both of these currencies benefitted from the quicker rollout of vaccines and a firming in US and UK interest rate expectations.
However, notwithstanding this, the foreign exchange moves remained contained within relatively confined ranges.
Looking ahead to the second half of the year, the global economy looks well positioned to register a significant rebound in activity. However, risks remain given the nature of the Covid-19 pandemic.
This includes those in relation to the slow vaccine rollout in developing economies and the risks that delays inoculating all parts of the world could lead to vaccine-resistant virus mutations, necessitating the re-imposition of restrictions.
Another key focal point for markets over the remainder of the year will be in relation to inflation.
Specifically, whether central banks are proved correct in their widely held view that the spike higher in inflation will be transitory. The recent upturn in headline inflation rates reflects the recovery of oil and other commodity prices, a surge in shipping costs, the normalisation of prices in hard-hit sectors and an unwinding of indirect tax cuts.
These factors are expected to prove temporary. The biggest inflation risk could be the labour market, if a shortage of workers emerges, putting upward pressure on wages. US data will be closely watched in this regard over the coming months, as job growth has generally been below expectations in recent months.
- John Fahey is senior economist at AIB
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