Bond rout and equity rotation likely to resume

We are forecasting a very strong – but also somewhat uneven – recovery in the global economy over the next couple of years as the pandemic is gradually contained, with three key implications for asset allocation. First, we generally expect government bonds to underperform “risky” assets substantially as major economies re-open and fiscal policy remains supportive, despite the slight pull-back in yields over the past few weeks. We expect China’s bonds to buck the overall trend though, since China is the sole major economy that we forecast will lose momentum this year. Second, we anticipate that the sectoral rotation within many risky assets markets, favouring the industries that suffered when the pandemic struck over those that benefitted, will resume. This is mainly about the containment of coronavirus, but policy changes in the US could also contribute. Third, we think that the outlook for the US dollar now depends more on the relative pace of economic recovery and changes in bond yields between countries, rather than the huge global swings in risk appetite that were the key driver last year. We project that the dollar will strengthen against the euro, Japanese yen and EM currencies including the Chinese renminbi, but weaken slightly against sterling and a handful of other DM currencies.