Many assets prices were largely unchanged over the past week, in the absence of material newsflow or a catalyst to provide additional market direction. US equities edged to new record highs and corporate spreads tightened a little, with the US high yield index dropping below 4% for the first time in its history. 

 

However, market moves were fairly muted, with the lacklustre performance of new corporate bond issues suggesting that the impetus to drive spreads much tighter seems to be waning. Core government bond yields were little changed on the week in the wake of a relatively benign US inflation report.

 

Meanwhile, a somewhat softer dollar made for a better week for emerging market assets, though overall returns in both hard currency and local markets remain slightly negative since the start of 2021.

 

Comments by Larry Summers that the Democrat Administration risked over-stimulating the US economy raised some eyebrows, though clarification suggested that it was not the quantum of stimulus being questioned, rather the manner in which it is delivered.

 

From our perspective, we believe that measures related to infrastructure spending and investment in green technologies will follow on the heels of the Covid support package currently being debated, and these long-term investment plans may help to boost growth over time. 

 

Notwithstanding this, the decision to implement the budget reconciliation process in order to drive through the current package may mean that this lands at a figure around USD1.5 trillion, which is a bit larger than our earlier estimates, with the benefits of this stimulus arriving a little earlier than we had previously thought likely.

 

In this context, with Covid infections receding and vaccine deployment advancing, we are content that the broader reflationary theme since the start of the year remains in play.

 

 

We doubt that central bank policy accommodation will start to wane until the second half of 2021 and perceive that US policymakers will be content to see that measures of financial conditions, such as the GS index, are at record ‘easy’ levels for the time being. 

 

At some point, worries relating to bubbles and financial stability may lead to more hawkish rhetoric, but there is no pressure to move in this direction with the economy still some way from full employment. Yet, with GDP forecasts moving up to 7% for the calendar year, it seems likely to us that this output gap will be closed in the second half of 2021. 

 

Consequently, we think that the Fed won’t be concerned to see yields drift a bit higher in the next few months. Thus far, the move upwards in nominal yields has been resisted in real yields, as inflation break-evens have widened to 2.2%. 

 

However, we doubt that this will be the case for much longer. Of course, a rapid move up in real yields could be a pretty bearish signal for risk assets, though we think it is more likely we’ll see a more steady and modest trend upwards in the weeks to come.

 

 

Italian spreads have continued to rally, in thrall to the idea of Mario Draghi as Italian prime minister. We are hopeful that Draghi can position himself at the centre of the debate to re-shape the fiscal rules governing the monetary union, once the German elections in September are out of the way. 

 

There is a path to Italy having a bigger voice within the EU, creating a closer and more robust union, which should help to continue to reduce the risk premium attached to Italian assets. Yet, this is also taking a lot on trust. 

 

The reality of governing may prove a much more challenging task for Draghi in the weeks to come and anyone who has spent time following Italian politics will know that it certainly won’t be plain sailing.

 

Meanwhile, positive news in the UK of falling infection rates and further robust progress regarding vaccinations has been tempered by growing anecdotes of EU trade disruption and moves by the UK government, which will continue to greatly curtail international travel for the months to come. Against this backdrop, it may be more difficult for the UK and the pound to continue its recent outperformance. 

 

 

Elsewhere, the continued rally in crypto currencies was the other major source of excitement over the past week, with Bitcoin topping USD45,000 in the wake of Tesla’s announcement that it has invested USD1.5 billion of its funds into the unit and that it plans to start accepting it as a source of payment. The ‘FOMO’ generated as Bitcoin prices have ascended by 500% in the past four months continues to draw new investors towards the asset class. 

 

However, we would note that from an ESG perspective, such investments have particularly negative consequences. Aside from concerns that crypto currencies are heavily utilised to finance criminal activities in a non-regulated market and that lax governance of coin exchanges potentially exposes retail investors to catastrophic losses, an increasingly important concern relates to the energy consumption associated with computer-heavy coin ‘mining’ activities. It was estimated that the electricity consumption from digitally mining Bitcoin is already greater than the total electricity consumption of a country the size of Argentina, even before the latest spike in prices.

 

As crypto-currency prices rises, so does the incentive to mine, meaning that energy consumption may continue to rise at an alarming rate. In this context, investors should question whether the carbon reduction one may believe one achieves by investing in Tesla, relative to traditional auto manufactures, has in practice been offset by a carbon-increasing decision to allocate corporate funds to Bitcoin and drive its price higher. 

 

Either way, it can be argued that the hipsters and millennials piling into cryptocurrencies right now simply don’t care for ESG and are more motivated by a desire to get rich quick by chasing prices.

 

 

We would not be surprised if next week isn’t another relatively quiet week with the New Year holidays underway in China. More generally speaking, there is also a sense that there are currently fewer macro drivers of volatility than we may have been used to when Trump was tweeting from the White House. 

 

Perhaps there is a sense like a sailing boat that a predictable breeze is now starting to fill the sails of the global economy. Reflationary trends seem set to drive us forwards, with the main source of risk seeming to stem from a more rapid move-up in rates. 

 

In times to come, we know that some tricky tacking manoeuvres will be required when policy needs to turn course, but this won’t be for a time yet. For now, we can sit back and look to make more modest adjustments to the overall portfolio balance without the need to make more assertive changes.