3 factors financial markets should watch over the next six months

The pace of vaccinations globally, the US Federal Reserve’s policy intentions and the UN climate change conference could all move markets

Tai Hui

Published: 4:30pm, 2 Jul 2021

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As the midpoint of 2021 passes, three factors are likely to shape the investing future for the next six months and beyond.

First, the global pace of vaccinations will determine the speed of the recovery. The US and Britain have led this race in the first half of the year, resulting in a robust domestic economic recovery so far. Europe and China have also accelerated their progress in recent weeks.

While vaccine hesitancy around the world could prevent these economies from reaching the 60-70 per cent rate that’s required for herd immunity, a higher level of vaccination, with effective testing and tracking programmes, should help contain the pandemic and support growth recovery.

One question is whether the highly transmissible Delta variant could threaten this recovery. It is becoming more dominant in Europe and the US, especially among those who are not vaccinated. But, at least for those who have been vaccinated, the rate and severity of infections are lower.

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Therefore, instead of just looking at infection numbers, governments will also need to take their signals from hospitalisation rates and deaths when setting lockdown policies.

For Asia, after a slow start, vaccination momentum is picking up in Hong Kong, Japan and South Korea. Southeast Asian economies, such as Thailand, Vietnam and the Philippines have lagged behind but should receive more vaccines in the coming months.

Overall, global economic recovery should continue, but the pace will be uneven. For those at the forefront of recovery, their central banks will need to start thinking about reining in aggressive monetary stimulus.

China has already started normalising policy. While the People’s Bank of China has kept interest rates unchanged, the overall pace of lending growth has slowed towards pre-pandemic levels.

This has dampened market sentiment and triggered liquidity concerns for some financial institutions and real estate developers. Although China has allowed more companies to default on their debt, official intervention is still likely if a default were to jeopardise financial system stability.

Residential buildings are seen under construction in the new city area of Yumen, in China’s Gansu province, on March 31. In June, China’s banking regulator warned small banks against growing their property sector loan portfolios. Photo: Bloomberg

The US Federal Reserve’s policy intentions will be another critical factor in setting markets’ tone. In its June Federal Open Market Committee meeting, committee members revised upwards their 2021 economic growth and inflation projections significantly, reflecting the reopening of the service economy.

More importantly, more members are expecting the first policy rate increase to take place in 2023, instead of after 2023. The Fed also looks set to start scaling back its asset purchase programme in early 2022.

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A a result, US government bond yields should rise further. However, higher interest rates are not necessarily bad for equities.

In fact, data shows that US and other global equities can still generate positive returns in a rising government bond yield environment, which tends to coincide with periods of economic and corporate profit recovery.

The challenge will be for those assets that do not generate any income. This includes gold and cryptocurrencies. Equities with high valuations are also vulnerable, since part of their valuation is supported by ample liquidity, which is now gradually being withdrawn.

This could point towards a more choppy time for US technology companies, while benefiting stocks that are relatively cheap or supported by the cyclical recovery, such as financials, industrials and consumer-related companies.

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The third event to note is the UN Climate Change Conference in Glasgow, or COP26, in November. Climate change has been a significant consideration in both national and international policies. US President Joe Biden’s infrastructure proposal includes a significant upgrade to America’s renewable energy grid.

The European Union’s recovery fund is supposed to facilitate a green recovery. China is also stepping on the accelerator in developing its renewable energy sector to reduce greenhouse gases domestically and tap into international demand for green energy.

COP26 will be an important pointer on whether major economies focus on collaborating to fight climate change, or blaming each other. Also, it will be interesting to see whether greenhouse gas emissions could be used as a new form of trade barrier, under which products from more-polluting sectors or countries face additional tariffs or greater import restrictions.

China and the US have pledged to work together on this global issue, but geopolitics could still dominate this plan.

The backdrop for the second half of 2021 should be a positive one. Yet, as we move away from the battle against Covid-19, other challenges will come to the fore on both the macroeconomic and policy fronts.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management

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