By Keith Wade, Chief Economist & Strategist at Schroders
A strong recovery in global growth continues to drive the outlook for assets. Schroders see inflation building in 2022, requiring tighter monetary policy.
Despite making positive gains, equities had a bumpier ride compared to previous quarters. There were increasing concerns over the prospect of policy tightening, in response to stronger growth and inflation, by some of the key central banks.
This led investors to shift back into more defensive and growth-orientated markets. The S&P 500 led the way on performance while Japanese equities were left behind. Both government bonds and credit made some positive returns.
Commodities remained the best performing asset class thanks to the surge in the oil price.
The success of the vaccine roll-out, policy support and the adaptability of many firms in operating with significant Covid-19 restrictions has led us to upgrade our global growth forecast. In the near-term, inflation is expected to be higher due to the rise in commodity prices and the re-opening of the service sector.
These factors should fade, but next year, we see inflation building as the output gap closes and capacity tightens. Against this backdrop, we expect the Federal Reserve to begin tapering asset purchases in December this year and to start raising interest rates in Q4 2022.
The greatest risk to our central macroeconomic view is a ‘Boom and bust’ scenario where there is a stronger than expected increase in growth. Inflation also rises strongly, and monetary policy is tightened resulting in a significant fall in economic activity next year.
Given the strong recovery in global growth, we maintain our overweight to commodities. This asset also offers some protection from cost-driven inflation.
Meanwhile, we are still positive on equities, but underweight on government bonds and credit. We have turned negative on US investment grade bonds due to very expensive valuations.
On equities, we expect robust earnings growth will offset the impact of higher bond yields. Within equities, we prefer the less duration sensitive areas of the market, such as Europe and the value sectors.