But sentiment suddenly changed when former President Donald Trump banned travel from most of Europe and the World Health Organization officially declared Covid-19 a pandemic on March 11.
The latest: many of the features of 2020 are still clear – and not just in the locks, social distance and to work from home. The exuberance defined on stock markets over the past twelve months has driven equities to their highest point this year.
The coronavirus is still with us, but investors are now making a quick and strong recovery while the explosion of vaccines fits in and prepares the United States for another huge stimulus package.
Goldman Sachs predicts 7% US GDP growth in 2021, a level not seen since 1984.
Big risk: like this time last year, equity investors may underestimate the size of potential barriers. Ironically, a booming economy may not be good for equities because it could increase financing costs for companies and rob stocks of their main selling point: better returns.
While a strong recovery is good for corporate earnings, higher rates make debt more expensive, which can become a problem for companies that have borrowed heavily through the crisis. Stocks also look relatively less attractive as bond yields rise.
Stay calm: the Federal Reserve has made it clear that it is prepared to tolerate higher inflation if it means business recovery and unemployment falling.
As the U.S. labor market still has about 10 million jobs since the pandemic, it could take some time before tariffs are taken off the floor.
“The background will support equities in 2021,” said Roger Jones, head of equities at London & Capital. “Long-term structural headwinds for inflation – demographics, technological advances and high debt levels – are stronger than ever before. On top of that, equities can cope with inflation as long as it does not stay above the 3% level,” Jones said.
The European Central Bank may have a new problem
A sustained rise in consumer prices may seem far-fetched in Europe, where economic activity is still hampered by barriers, stimulus has been curtailed and the outlook for GDP growth has weakened this year.
Despite all this, inflation in the region has increased, and if bond yields can continue to take rising policymakers, they may eventually be forced to take action.
What happens: The European Central Bank meets on Thursday and investors want to know how it thinks about inflation. They will also want the assurance of Christine Lagarde, President of the ECB, that the central bank does not intend to tighten the financing conditions.
“The ECB will mainly try to reduce the recent rise in bond yields and call it small, driven by technical factors and concentrating on real yields,” ING head Carsten Brzeski wrote in a note on Friday.
Brzeski expects the ECB to emphasize that asset purchases can be increased if necessary, and that it will begin in the coming weeks to boost the stimulus to keep financing conditions favorable.
Watch here: In an interview with The Economist last month, Lagarde said the ECB had used about € 800 billion ($ 955 billion) of its € 1.8 billion ($ 2.1 billion) Pandemic Emergency Purchase Program.
“We still have a lot. If we need it all, we’ll use it all,” she added.
As the recent volatility in the bond markets indicates, a lot can still change within a few weeks. Once economies reopen, a sudden rush for goods and services can lead businesses to raise prices. Excessive savings in Europe will also accelerate recovery if households spend that extra cash.
“Once the restrictions are lifted and fears of the virus recede, it is reasonable to expect prices to rise,” ING economists, including Brzeski, wrote in a note last week. “Headline inflation in the eurozone could easily accelerate above the magic level of 2% this year.”
The big picture: at least for now, the European economy seems far from overheating. GDP has shrunk again in the last three months of last year amid new closures, and with many of these measures still in place, growth is unlikely to perform much better in the first quarter.
A slow explosion of vaccines and relatively modest stimulus will also weigh on Europe’s recovery. In the absence of a rise in wages, the ECB is unlikely to respond to short-term inflationary movements, Brzeski said.
Following
Friday: US PPI and consumer sentiment, industrial production in the EU