The infectious “Delta variant” is changing the dynamics of the pandemic and the contours of the global recovery. In Citi’s view, to “Reconnect the World” and achieve a full, global economic recovery, the spread of COVID-19 will have to be better controlled. This is unlikely before year end.
Citi analysts agree with Chairman Powell that the recent, unusual inflation surge could abate and that core inflation may be at a slower pace a year from now once COVID-19 distortions fade. What is highly notable is how strongly financial markets have accepted this view.
The premium level of US yields over other developed markets and the latest COVID-19 developments now argue for at least a modest reversal higher in the US dollar.
A setback in the fight against COVID-19 could see the US and China markets outperform again, with “growth” shares feeling the added relief from COVID-19 blunted interest rate pressures.
Citi analysts advise against reacting to or chasing short-term COVID-19 distortions in markets. There may be many surprises that could challenge the confidence of investors from the pandemic. The time is ripe to upgrade the quality of assets in Citi’s portfolios and to seek sustainable drivers of returns in the face of what are likely to be more volatile markets.
Higher Quality Assets Could Prevail
Truly ending the COVID-19 pandemic globally may likely mark the end of US monetary policy easing and see the Fed act to ensure inflation does not become entrenched. The highly sensitive bond and foreign exchange markets suggests it would not take a very large tightening steps for the Fed to achieve this. In Citi’s view, a looming tightening cycle beyond COVID-19 does suggest choosing higher quality assets.
With a half year of policy tightening behind it, China’s post COVID-19 equity market performance has only slightly exceeded Brazil’s. Given China’s preeminence, there are reasons to be optimistic that it can again lead markets higher. In short, evidence is accumulating that the post COVID-19 world economy is going to be different than the pre COVID-19 economy – and that could be reflected in both valuations and new market relationship.