as of June 30, 2021
Vaccines have been rolled out at a tremendous pace in the US and UK, while the EU and Japan have seen an improving pace of vaccinations. This has allowed broad re-openings to begin in much of the developed world, driving a mini-boom of activity as pent up demand is released, benefiting both service sector and manufacturing firms. Less vaccinated developing countries across Asia Pacific saw some restrictions returning, although the impact on global growth was limited. Forward looking indicators suggest that the expansion is likely to continue. While the US and UK are expected to reach peak growth rates this summer, the Eurozone still has room to accelerate. However, the labor market is tightening, particularly in the US, which could become a headwind moving forward.
During Q2, inflation readings came in above already elevated expectations driven by largely by supply chain pressure and a tightening labor market. Monetary policy remains quite dovish in most developed countries, with little change in policy among the major central banks. The Fed stressed that it viewed elevated inflation readings in the US as transitory. However, the Fed’s June dot plot, a projection of the federal funds rate, suggested a slightly less dovish stance, projecting two rate increases in 2023. Fiscal support is slowing, but it is not going away. Pandemic related fiscal programs, such as enhanced unemployment benefits, are set to be phased out. We are likely to see infrastructure programs moving forward, with a bipartisan group of US senators agreeing to a $1.2T package, although the spending would be spread out over several years.
Global equities continued to move higher in Q2, with the MSCI ACWI index gaining 7.4% for the quarter and 12.3% year-to-date. The S&P 500 returned 8.5% during the quarter, outpacing most other regions. Year-to-date, the S&P 500 has returned 15.3%. International developed stocks rose 5.2% in Q2 and 8.8% year-to-date. A weaker dollar added 40 basis points to US dollar returns during the quarter. Emerging market equities rose 5.0% in Q2 and 7.4% year-to-date in US dollar terms.
Within fixed income, the Bloomberg Barclays Aggregate index gained 1.8% during Q2 with corporate bonds outperforming Treasuries as credit spreads declined. The yield curve flattened during the quarter, with 3-month yields rising 2 bps, while 10- and 30-year yields fell by 29 bps and 35 bps, respectively. High yield bonds gained 2.7% during the quarter, as credit spreads fell by 40 bps to 2.7%, almost 200 basis points below the long-term median level of 4.6%.
Economic re-openings in the developed world are likely to drive strong earnings growth over the next couple of years, which should benefit equities. While equity valuations appear stretched, we believe we are in the early stages of a strong recovery, which should benefit stocks and other risk assets. Inflation is likely to remain elevated this year as year-over-year figures are compared to depressed levels in 2020. We expect inflation to settle around the Fed’s target over the next year, but the risk of an inflation surprise has risen. The Fed is unlikely to raise rates in the near-term, but it could begin to taper its asset purchases.
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