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Quarterly Wrap: June 2021

George Lin explains that despite a somewhat volatile quarter, driven by central bank and economic uncertainty in the US, growth investments (such as shares) delivered positive returns over the June quarter.

       Written by George Lin
Senior Investment Manager | Colonial First State

Over the three months to 30 June, the global economy continued to recover at an uneven pace – particularly as developing nations struggled with coronavirus. As concerns about higher inflation in the US escalated, the US Federal Reserve (the Fed) delivered a hawkish surprise to markets. And despite bond markets pricing in earlier-than-expected rate rises, global share markets performed well. By quarter’s end, the ASX 300 was up 8.5% while the Australian Dollar traded at 75.08 US cents.

Key economic developments

The most noticeable pandemic development was the divergent public health outcomes between the developed and developing world. Developed nations have largely managed to contain coronavirus due to their successful vaccination programs. In the US, for example, 46% of the population is fully vaccinated and another 7.7% of the population is partially vaccinated. A similar trend is taking place in Europe and the UK. Consequently, the pandemic has rapidly diminished as a key economic and market driver in developed regions. However, the situation in the developing world is different. Several Asian nations struggled to contain the latest wave over the quarter, but they weren’t alone. Episodic and localised coronavirus outbreaks also impacted cities around Australia. A two-week lockdown in Victoria was followed by a cluster and subsequent lockdown in Sydney, while other regions such as Queensland also announced snap lockdowns. The slow pace of vaccinations in Australia was a concern. As at the end of June, about 5% of the population was fully vaccinated.

The global economy continued to recover at an uneven pace over the quarter. Many developed economies followed a similar pattern of recovery – that is, a recovery in the manufacturing sector followed by a recovery in the services sector as social-distancing measures were eased. While growth in the manufacturing sector has slowed, this is offset by the recovery in the services sector. Most importantly, growth in the European services sector was positive at quarter’s end and, assuming continuing improvement with the pandemic, this should accelerate as the economies re-open.

Financial markets focused largely on US economic data and the implications for monetary policy. The combination of higher-than-expected inflation data and weaker-than-expected employment data sparked concerns about both the strength of the US economic recovery and the inflationary outlook.

As to employment, two US labour force reports indicated that growth in non-farm employment was below market expectations. While this was disappointing, it has likely overstated the weakness in the US job market, particularly as the trend in jobs creation has been strong. For instance, on a three-month basis, non-farm payroll increased at a rate of around 550,000 – robust by historical standards. The data was only disappointing given the high expectations of monthly job growth of about 900,000. The weaker-than-expected data has also been caused partly by supply-side constraints and temporary dislocations, such as the generosity of unemployment benefits relative to the minimum wage in some states, as well as the ability of working parents to return to work given the closures of schools. Both barriers should disappear over the next few months. Other data points also paint a more positive picture. For example, the number of job openings has steadily increased since November and the latest data has indicated there are 9.8 million job vacancies in the US. Surveys have indicated that a number of employers have found it difficult to hire people.

Source: Factset

As to inflation, a string of US Consumer Price Index (CPI) data points (which show that consumer price inflation has been running at a level significantly above the Fed’s target of 2% to 3%) dominated headlines for financial markets. US CPI rose 5% year-on-year in May, which was the highest level since August 2008 when CPI rose 5.4%. Core CPI, which removes the impact of volatile items such as energy and food from the CPI basket, rose 3.8% year-on-year – the highest level since 1992. Although the base effect (which exaggerates year-on-year inflation due to the fall in CPI levels in early 2020) and some transitory factors (such as sharp increases in air tickets, price of hotel accommodation and used car prices) all contributed to the sharp rise in inflation, it is difficult to attribute all of the rise to either. It seems that part, if not most, of these price increases have been driven by cyclical forces such as stronger demand, pockets of labour shortage and supply-side constraints which may be more permanent than investors (and the Fed itself) had hoped for.

Source: Factset

In the US, the Fed’s June FOMC meeting (that is, the body which determines monetary policy) resulted in a hawkish message to financial markets as the Fed played catch-up with markets in terms of the sentiment on inflation and interest rates. The “dot plot” (that is, the forecast for policy rates as per members of the FOMC) was revised upward. The median dot plot shifted from no increase in the Federal Funds Rate in 2023 to two rate hikes. Further, the distribution of the dots suggests that if inflation continues to surprise on the upside, the central bank may raise policy rates three times in 2023, with a 2022 rate hike also a possibility. This was reinforced by Chairman Powell’s post-meeting comments, where he continued to characterise higher inflation as transitory and, in an important shift in rhetoric, acknowledged the risk of higher inflation as demand rebounds faster than supply.

The economic recovery in Australia consolidated over the quarter despite episodic outbreaks of coronavirus. Employment growth, after disappointing in April, surged to 115,000 in May – the highest level since October 2020. The unemployment rate fell to 5.1%, which was slightly above the pre-pandemic level – with all jobs lost during the pandemic now recovered. Leading indicators of employment, such as the ANZ Job Advertisements series, have pointed to further job growth. The level of corporate confidence also improved steadily over the quarter – a positive signal for future corporate investment. Finally, the level of consumer confidence has surged since August 2019, while retail trade has grown steadily since the start of 2020 despite some volatility.


The Federal Budget for 2021-22 is a continuation of Keynesian fiscal policy to support the economy for longer. A better-than-expected economic recovery and higher commodity prices resulted in a $37 billion lower fiscal deficit for the 2020-21 financial year compared to previous estimates. The improvement allowed the government to announce a number of measures ranging from the continuation of the Low and Middle Income Tax Offset to additional infrastructure spending totalling $96 billion over the next five years. The extra fiscal stimulus is “front-loaded” – with $18 billion (or around 0.9% of Gross Domestic Product) to be spent in 2021-22. Importantly, the government has said its plans for fiscal consolidation were delayed until unemployment is below the pre-coronavirus level of 5% (rather than “comfortably below 6%”).

Source: Factset

Key market developments

Bond markets re-priced quickly after the June FOMC meeting, with the re-pricing centred on the “belly” of the US yield curve. Yields in the three-to-five year segment rose sharply as markets priced in earlier policy rate rises, while the 10-year bond yield has fallen modestly since the meeting. Over the quarter, 10-year bond yields in developed markets drifted lower as US economic data disappointed. Although this fall is surprising given the concerns about inflation, it can be explained by the more hawkish stance of the Fed. Markets were concerned about the Fed’s willingness to tolerate higher inflation, but the June FOMC meeting suggests the central bank is still data-dependent and willing to raise policy rates – albeit with a lag – to fight higher inflation. Australia’s bond market followed a similar trajectory. While Reserve Bank officials reiterated their commitments to low interest rates, stating they don’t expect to increase the target cash rate until 2024, bond investors have still priced in an earlier rate increase. As in the US, the Australian yield curve flattened, with a rise in three-year bond yields closing at around 0.4% in the month of June.

Share markets had a somewhat volatile quarter as investors struggled to interpret conflicting US economic data and decipher the Fed’s sentiment. Key developed share indices all finished higher, however. In particular, the ASX 300 rose 8.5% over the quarter and was one of the best performing developed markets over the period. Surging but volatile commodity prices, especially the iron ore price, were one of the drivers behind this performance. US share indices also had another stellar quarter despite a modest correction after the June FOMC. The S&P 500 rose about 8% while the NASDAQ rose more than 9%. In a reversal following the March quarter, growth stocks in the US outperformed value stocks by 4.9% over the three months as lower bond yields boosted the share prices of tech stocks.

Source: Factset
Source: Factset

Forward-looking views

A key risk to monitor closely is the impact of the various lockdowns in Australia. Investors have so far reacted calmly; while Australian bond yields have fallen, the reaction from share markets has been relatively mild. The consensus is that while the level of confidence and consumer spending may be impacted, this should be temporary. However, this confidence may change if the extended lockdowns (especially in Sydney) last even longer than anticipated.

Despite the string of somewhat disappointing economic data in the US, the global reflation theme remains intact. However, caution is needed against greater volatility in markets and the stretched valuations of share indices. US economic growth is still positive, though weaker than market expectations. Investors have largely priced in the good economic news (particularly in the US) which suggests that unless there is a marked acceleration in the pace of economic recovery, returns in share markets should be more subdued. However, there are opportunities for other economies, such as Europe, to play “catch-up” with the US as countries continue re-opening their economies.

The threat of higher cyclical inflation in the US is real and there is a reasonable possibility that it will overshoot markets’ expectations over the next year. While the recent US CPI data has exaggerated US inflation due to a number of transitory factors, several leading indicators of inflation are all pointing to a cyclical rise; the upstream price, as measured by Producer Price Index, is rising while commodity prices are higher and the labour market continues tightening. The risk is that while US inflation may decline once the transitory factors fade, it may still be too high for financial markets.

The June FOMC indicates that the Fed has a limited tolerance of higher-than-target inflation despite its average inflation targeting policy. The dot plot at face value implies a rate rise in 2023 – most likely in the first half of the year. The central bank will likely want to end its asset purchase program before starting to increase policy rate. This suggests that a tapering in early 2022 is inevitable and, given the Fed’s preference is not to surprise markets, a formal announcement on tapering will likely be made by the end of this year – perhaps as early as the September meeting. A more aggressive monetary policy tightening by the central bank, with a rate hike in second half of 2022, is a real possibility if US inflation accelerates further and does not decline as rapidly as the Fed’s current expectation.


Overall, one of the biggest ongoing concerns is that most developed share markets are overvalued by historical standards. On both trailing and forward price-to-earnings ratios, these indices are trading at, or close to, the top of their historical valuation range. Expensive valuations have not been an issue so far in the recovery due to a combination of low interest rates and a robust economic recovery which enable corporate earning to recover sharply from their mid-2020 lows. But as interest rates rise and the economic recovery slows in 2022 and 2023, the environment for shares may be challenged.

Source: Factset

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