Heightened Risk Aversion as Investors Grow Anxious
Investors are becoming increasingly cautious about the potential impact that the recent resurgence in COVID-19 cases will have on the global economic recovery. The highly contagious Delta variant continues to devastate many countries, threatening to undermine the gains some were able to eke out during the first half of 2021. This strain of the virus is the most predominant in the world and has been detected in more than 130 countries globally. The Center for Disease Control and Prevention (CDC) estimates that it was the cause of more than 80% of new US Covid-19 cases by the end of July 2021. The rise in the number of cases globally has prompted a reinstatement of restrictions on activity and movement, stoking concerns about the possible impact on global economic growth which has been weighing on investor confidence.
Some aspects of the US economic recovery remain strong, including the labour market where hiring continues apace and labour demand continues to strengthen. In July 2021, the unemployment rate fell to 5.4% from 5.9% just one month earlier. However, there are emergent indications that consumers may be a bit more hesitant given recent developments with the pandemic and renewed waves of infections. Retail sales for the month of July fell 1.1%, largely driven by both dampened activities due to the Delta variant as well as fading government stimulus. Consumer spending makes up approximately 70% of the US economy and trends in retail sales are usually indicative of the strength of the US economy. Further analyzing consumer behavior, one of the key consumer sentiment indices in the US showed a 13% plunge to 70.2 in an early August, relative to July’s reading, even dipping below April 2020’s reading of 71.8, which was the lowest during the pandemic.
In China, there are also early signals that the economy may be slowing due to both COVID-19 uptick as well as the recent adverse weather. The authorities have reinstated widespread travel restrictions in some areas and have imposed mass testing. Chinese retail sales rose 8.5% in July (year on year), missing most forecasts. Auto sales, which is the largest component of retail sales by value, was the only category to contract in July, down 1.8% year on year, hit by the chip shortage which significantly affecting manufacturing. Furthermore, online shopping growth fell sharply to 4.4% in July, well below an average of 21% for the past five years. The rapid spread of the Delta variant in Asia has severely affected supply chains – a key container port in China had to be partially shut in early August after a COVID-19 case was detected, disrupting trade during what is usually a busy period for businesses. Chinese production growth has also moderated, with industrial production increasing by 6.4% year on year in July, down from 8.3% in June, and below the 2021 average of 9.5%.
While China was the only major economy to post positive economic growth in 2020, and was able to return to pre-pandemic expansion earlier in 2021, the expansion seems to be losing steam due to higher costs associated with supply chain disruptions as well as the severe weather, in addition to the new restrictions that are in place. During the second quarter of 2021, the Chinese economy grew 7.9% (year on year), up from the 2.3% recorded for 2020 and the IMF projects an 8.1% expansion for full year 2021.
In the energy market, crude oil prices continued to trend downward, weighed heavily by the weakening prospects for global demand. After reaching a high of USD74.69 in July 2021, WTI price has since declined by around 10%, driven largely by disappointing economic data in the world’s two largest economies – the US and China as well as renewed limitations on travel and mobility, which may curb demand for fuel. On the supply side, the OPEC+ alliance has maintained their output policy, and will increase output by 400,000 barrels a day in August.
The growing uncertainty associated with the pace of growth has prompted investors to take a more cautious approach. Over the two months, there has been a shift towards so-called ‘safe-haven’ assets, at the expense of the risky asset classes, as shown in figure 1, where only US treasuries, gold and US equities have posted positive returns. After peaking at 1.742% on 31 March 2021, the yield on the US 10-year Treasury has fallen to 1.263%, indicative of the softer economic data in both the US and China. Also supporting the rally in safe-haven government treasuries has been the developments in Afghanistan. The US dollar, as measured by the DXY Index on Bloomberg, is up to its highest level since March 2021 as investors seek safer assets. Gold, often viewed as a hedge against inflation and a safe haven asset, also increased over the past few weeks reaching as high as USD1,829.47 per troy ounce in mid-July.
Alternatively, riskier assets such as equities as well as emerging market bonds have erased some of their gains for 2021 over the past two months. Since July, emerging market stocks are on average down by 8.6%, while emerging market sovereign spreads have widened by around 2%.
The US Central Bank has indicated that it intends to keep policy interest rates at its current level at least until 2023 to support the labour market, which continues to strengthen, but not near pre-pandemic levels. At the same time, the Fed has suggested that it is willing to tolerate some level of inflation, which has picked up recently and is widely regarded as ‘transitory’. The US Central Bank is expected to signal future direction of monetary policy plus timing for tapering its bond purchasing program as more Fed officials have turned more hawkish. Nevertheless, from a fundamental perspective, the global economic recovery faces significant headwinds even as vaccination programs intensifies across the world. Softer economic data from some of the world’s largest economies will continue to weigh on confidence and will dictate investors’ risk appetite in the coming months.
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