NNIP: Intensifying pandemic-related pressure on growth

January 28, 2021

While market expectations of an economic recovery in the second half of 2021 have not changed, the immediate outlook for growth continues to deteriorate. We see this reflected, for instance, in the softer flash PMIs in the Eurozone and the weakening of cyclical indicators across the emerging world. The early reading of the January Eurozone composite PMI was clearly weaker than in December and at 47.5 well below the neutral 50 mark. Meanwhile, the German Ifo Business Climate Index experienced its sharpest drop since last April. Tighter mobility restrictions and extended lockdowns are to blame. Given the persistently high infection growth and the delays to the EU vaccine supply, there is little hope that restrictions will be eased in the short term. And while the manufacturing sector has so far proved resilient, helped by global consumer demand shifting from services to goods and the strong recovery of the Chinese economy, the recent news of new lockdowns in China might start raising doubts as to the resilience of Germany’s manufacturing sector.

The new coronavirus outbreaks in Hebei and several other northern Chinese provinces have been modest in comparison with what we have seen in other countries or early last year in China itself. But the reaction of the authorities, by putting whole cities in full lockdown and closing them to the outside world, reminds us of how fragile the health situation still is. The Chinese way of dealing with the virus has proven effective, so it seems unlikely that it will spread rapidly across larger parts of the country. The authorities are willing to go to great lengths to contain the virus. Already, the central government has restricted travelling during Chinese New Year in February, which is likely to lead to at least a 40% decrease in trips relative to normal years. But while this must affect holiday-related consumption, it could also lead to more industrial production as migrant workers will be encouraged not to travel to their hometowns and work overtime instead. China and most of the rest of East Asia continue to be relatively successful in containing the virus. Other parts of the emerging world have never succeeded in suppressing infection growth and some are experiencing a painful new wave. The recent numbers look particularly worrying in most Latin American countries, South Africa and Indonesia. This has started to affect the economic data. From August, growth momentum in the emerging world as a whole had started to recover, at a faster pace than most people expected, but now we are seeing the first signs that this recovery is faltering (see figure). This is primarily the result of accelerating infection growth and lower mobility in the countries that have never had the pandemic under control. Thanks to the situation in East Asia, the EM recovery theme is not yet completely broken, but the economic outlook has deteriorated due to the worsening virus dynamics. This situation is exacerbated by the fact that the vaccination process in large parts of the emerging world will be much slower than in the US and Europe and that a return to normal after the crisis and the economic recovery will also probably be slow, only gaining pace in 2022.

Neutral on emerging markets due to worsening outlook

In our multi-asset model portfolio, we continue to have neutral positions in EM equity and debt. The worsening growth outlook for emerging markets is one of the reasons why we decided not to jump on the EM equity bandwagon. Since the beginning of the year, this category has performed very well, in our view mainly driven by global liquidity expectations. If we look at EM specifically, we see central banks gradually abandoning their super-easy policy stance and credit growth still going nowhere. On top of the short-term growth challenges due to the pandemic, we are worried about the longer-term growth prospects due to the dramatic widening of fiscal imbalances and the lack of structural reforms and credible policies to bring public debt dynamics back on a sustainable path. In our regional equity allocation, where we have kept EM at neutral, we also closed our overweight in the Eurozone and our underweight in the US. The main reasons for these changes are the painfully slow vaccination rate in the Eurozone compared to the US (with less than 2% of the population vaccinated compared to 7% in the US), the planned amount of fiscal stimulus which will likely remove the risk of a fiscal drag in the US this year, and a somewhat less convincing future policy path for the European Central Bank.

Increased exposure to oil

Within commodities, we added a moderate overweight in US WTI crude oil – we already had an overweight in Brent – and downgraded palladium from a large to a moderate overweight. This move has further increased the cyclical tilt in our commodity allocation. The main reason for the reduction of our palladium overweight is the risk of more profit-taking following the good performance in the second half of 2020. Still, this precious metal should continue to benefit from increasing green policy targets, related stimulus and a recovery in the car sector. We decided to add exposure to oil as we consider Saudi Arabia’s production cut in February and March, amounting to 1 million barrels per day, to be enough to compensate for the lockdown-related oil demand weakness in the first quarter of 2021. The International Energy Agency downgraded its global oil demand expectations for the whole year by 300,000 barrels per day, with most weakness in the first quarter. For the medium term, the demand outlook for oil has improved, thanks to the increased likelihood of large fiscal stimulus in the US after the Democratic victory in the Georgia Senate runoffs. Meanwhile, the green ambitions of the Biden administration should lead to lower oil capex and more production constraints. Already, the new president has cancelled the Keystone XL pipeline permit and banned drilling in the Arctic region as well as on all US federal land. And with increased scrutiny on fracking practices, it will be difficult for shale oil producers to increase production this year. In this environment we expect oil inventories to drop and prices to rise.