as of September 30, 2021
The third quarter of 2021 started with optimism over re-openings, but ended with global slowdown fears. Over the first half of the quarter, the US, UK and much of Europe relaxed restrictions, which helped drive markets. However, concerns over the delta variant prompted some economies, particularly in the Asia Pacific region, to re-impose restrictions, adding to existing supply chain pressures. Bottlenecks in supply chains are weighing on economic activity, and the re-opening surge in demand is putting upward pressure on prices.
During the quarter, inflation readings remained elevated, driven mainly by strong demand, supply chain problems and tight labor markets. Many central banks are likely nearing a point where they will begin to taper their asset purchases. The Federal Reserve’s June dot plot, which projects future interest rates, suggests a potential rate hike in 2022, with most committee members expecting at least one rate hike by the end of 2023. Additionally, many pandemic related fiscal programs, such as enhanced unemployment benefits, have expired. The fate of President Biden’s economic agenda is in question as progressive and moderate Democrats debate the size of the programs. While further fiscal programs are likely to pass, they may be smaller than proposed.
Global equities posted modest declines in the third quarter, with the MSCI ACWI index, a measure of global equities, falling 1.1% for the quarter, leaving it with an 11.1% gain year-to-date. The S&P 500 returned 0.6% during the quarter, outpacing most other regions. Year-to-date, the S&P 500 has returned 15.9%. International developed stocks fell 0.4% for the quarter, but remain up 8.3% year-to-date. A stronger dollar detracted 170 basis points (1.70%) from US dollar returns during the quarter. Emerging market equities fell 8.1% and are down 1.2% year-to-date. China and Brazil drove most of the negative return for the quarter.
Within fixed income, the Bloomberg Barclays Aggregate gained 0.1%, with Treasuries outperforming corporate bonds as credit spreads (the difference in yield between bonds of a similar maturity but with different credit quality) widened. The yield curve modestly steepened during the quarter, with 3-month yields falling 1 basis point, while 10- and 30-year yields rose by 7 basis points and 2 basis points, respectively. High yield bonds gained 0.9% during the quarter, despite credit spreads rising 21 basis points to 2.9%. Despite this rise in spreads, current high yield credit spreads remain roughly 175 basis points below the long-term median level of 4.6%
It is difficult to predict how long it will take for supply to recover, and some sectors may face issues over the intermediate term. However, we believe that market forces will align broad supply conditions with underlying demand in many sectors over the coming quarters. The potential for government intervention is a risk to this view. Central banks seem committed to a gradual removal of support. However, one downside risk for markets is that the Federal Reserve and other central banks tighten policy materially more rapidly than currently anticipated, which could occur if inflation proves less transitory than hoped. Political risks do not currently appear as prevalent as they were in 2020, although unexpected developments could lead to volatility and downside risk.
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