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Do markets face an autumn surprise?

Mirabaud Asset Management’s Head of Fixed Income Andrew Lake gives his review of the situation as we head into the fourth quarter

The last quarter of the year is just around the corner, and what an eventful year it has been.

I overestimated the rapidity of the recovery and re-opening, thinking the summer holiday season would have seen activity return almost back to normal. Delta spoilt the party somewhat, but I fully expect 2022 to be far more ‘normal’ once we get through this winter.

I also expected to see a resurgence in Emerging Markets in the second half. We certainly saw hard currency EMHY do well, but the resilience of the US dollar has somewhat delayed any local currency renaissance for 2021.

As always, China remains an enigma. The crackdown on various sectors has provided a salutary reminder to investors that China is not a typical capitalist free market economy. There are still limits.

For the rest of EM, idiosyncratic risks remain elevated, and it is difficult to make broad-based assumptions for the asset class as a whole.

Now, winter is upon us and the big question is: what could happen to upset the markets in the last few months of the year?

Momentum has certainly begun to falter, but this has yet to translate into the sell-off some market strategists expect. How bad will the flu season be and will we see elevated ICU occupancy that may or may not lead to restrictions upon our activity?

At this point it is too early to tell but there will certainly be some kind of ‘flu effect’, although it’s likely it will not be significant enough to have a serious impact. We are learning to live with the virus, and each wave has less of an effect, especially with the vaccine programme and increasing antibody levels. It would also seem as if the Delta variant has peaked.

What about the economy?

The narrative at the moment seems to have already become peak economic growth rolling into slowing economic growth, mid-cycle etc. I have also begun to hear the dreaded word ‘stagflation’.

Let’s be clear, we may have inflation with a slowing but still strong economy, but I do not think we are talking about actual stagflation – inflation combined with stagnant economic growth and high unemployment.

The issue will become more significant if these conditions weigh on consumer confidence and spending. If supply chain issues improve as expected, then we may well be in a Goldilocks environment for equities if bond yields remain low and tapering doesn’t cause a tantrum.

Nothing ever turns out as expected, and we have to acknowledge that risks have gone up – prices of goods are rising, as are the components of those goods. Wages are going up. This is going to lead to margin deterioration and pressure on earnings as we move forward.  Inflation also seems to be more sticky than transitory, with continued global supply chain problems.

It may well be that we have a sell-off before the end of the year as a result of elevated markets at a time when such risks begin to materialise into company earnings and outlooks. Tapering may also cause a tantrum. It is likely that any sell-off would be painful but short lived. There is still plenty of liquidity in the system - and so the merry-go-round continues.

There was much discussion of tapering last week, and the Federal Reserve did not disappoint, duly talking about beginning to turn the taps off in November, with one rate hike now priced in for 2022.

I thought the outcome was pretty hawkish, so was surprised to see Treasuries unresponsive. It took hawkish comments from the Bank of England the next day to really light the fire under the narrative and we saw Treasuries, Bunds and Gilts move wider in response.

It will be very interesting to see if the NFPR number bounces significantly in September as furlough rolled off and children went back to school. I think we may have a strong number that will continue to put pressure on Treasury yields.

Evergrande was the other big topic of conversation, and last Monday it seemed as if this over-indebted Chinese real estate company may well have been far more systemically important to global financial markets than anticipated.

However, by Tuesday this fear had reversed. While we still don’t know whether the US bond coupon that was due on Thursday 23rd September will be paid, it is unlikely that the Chinese government will allow this to become a systemic problem. There may well be more twists before a final resolution is found.

Looking ahead, risks have gone up and the margin for error has decreased. We know most of the headwinds that face us and the first trigger could be the NFPR number on October 8th.

We continue to view this as mid-cycle and so maintain our focus on credit.

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Head of Fixed Income


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