The second quarter was a frustrating period for many macro investors, with asset prices refusing to trend in one direction or another, despite some data surprises.
As the third quarter approaches, markets have generally remained calm. Major equity indices are near all-time highs, bonds are well off levels that would worry risk assets, and the trade-weighted dollar is close to where it began the year.
Three themes dominate as our Research analysts survey the landscape.
The global economy remains on solid ground, with Europe picking up the recovery baton
US and China growth may have peaked, but the euro area and emerging markets (ex-China) are picking up momentum. Some of this is mechanical: after contracting sharply due to COVID lockdowns in Q2, India and Malaysia are due a big rebound. But the euro area is definitely hitting its stride, with vaccination rates rising, economies reopening, and business and consumer confidence surging.
Real euro-area GDP growth gains steam in Q3 2021, but the output gap remains negative until the end of 2022
Source: Haver Analytics, Barclays Research
With half the year over, the recovery is well entrenched. Our analysts expect the global economy to grow 6.3% in 2021, close to the 6.4% rate the team forecast three months ago.
Inflation fears will not return to bond markets this summer
If investors believed the sharp rise in US inflation was here to stay, bond markets would have sold off. They did not, implying that the move is transitory. Our analysts agree.
A mix of supply chain bottlenecks, pent-up demand from reopening, and labor constraints should keep US price pressures high in 2021. But these factors should fade with time. The Federal Reserve’s preferred measure of inflation, core PCE, is expected to fall next year.
US inflation is expected to remain well above target this year, before moderating next year
Source: Bureau of Labor Statistics, Barclays Economics
It was a bit surprising how easily bond markets have reached this conclusion. But if the two strongest month-on-month inflation prints in 40 years did not ruffle bond markets in the second quarter, what will? Our Research team does not see inflation fears coming back this summer.
The chance of an abrupt Fed tapering that sparks a risk pullback are overblown
Yes, the Fed is gearing up to reduce asset purchases, and yes, the FOMC’s “dot plot” projects two interest rate hikes in 2023. But that is similar to what markets are now pricing. And our analysts expect a well-communicated paring down of purchases across 2022. That is the opposite of the abrupt and rapid tapering that can upset investors.
This leaves a bit of a quandary when it comes to asset allocation, given that stocks are now far above pre-pandemic levels. Our analysts have recommended overweighting global equities over fixed income for the past year, and that remains our view, if a bit hesitantly. Of course, we would have preferred better entry levels, and investors will have to pick their spots more carefully from here.
But the near-term macro backdrop remains benign, and our analysts think consensus estimates are still underestimating the recovery in corporate earnings. Moreover, although a “taper tantrum” is not expected in the bond market, our Research team simply does not see value at current rates. A grind higher – in both equities and bond yields – seems the most likely outcome.
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Barclays’ Global Outlook, published quarterly, contains recommendations for investors across all major economies and markets. Global Outlook: A grind higher is available to Investment Bank clients on Barclays Live.
Ajay Rajadhyaksha is Head of Macro Research at Barclays, based in New York. He oversees the global research and strategy efforts of the economics, rates, FX, commodities, emerging markets, securitised, and asset allocation teams. Since joining Barclays in 2005, Ajay has held various positions, including Co-Head of FICC Research and before that, Head of US Fixed Income Research and US and European Securitised Research.