By Chan Kung and Wei Hongxu*
Goldman Sachs recently released its investment outlook for the coming year, in which it forecasts trends in major markets. For the bond market, Goldman Sachs sees a steepening of the yield curve for U.S. nominal and real interest rates. For the equity market, Goldman Sachs says valuations are historically high for most of the world’s major stock markets, but the valuation of China A-shares still appears reasonable relative to its historical valuations and those of other global stock markets.
For the crude oil market, Goldman Sachs lowered its forecast for 2021 Brent crude oil prices to an average of USD 55 per barrel from the previous USD 59.4 per barrel, and lowered its WTI crude oil price forecast to USD 52.8 per barrel from the previous USD 55.9 per barrel. Goldman Sachs adds that a “winter speed bump” would simply delay prices returning to USD 65 per barrel from the autumn of 2021 to early 2022.
According to researchers at ANBOUND, Goldman Sachs’ outlook for the world’s main investment sectors is largely based on its judgments of the U.S. economy and policy environment. Their underlying logic is that COVID-19 will continue to affect the global economy and investment sector over the next year, and that the Federal Reserve will continue to implement expansionary monetary policy as the effects of fiscal stimulus are limited in the United States. These trends will bring new changes to the global financial markets in 2021.
Given that the COVID-19 pandemic will continue to spread in the coming year, the effects of monetary and fiscal loosening will continue as central banks and governments around the world step up their stimulus efforts. Even though great progress has been made in the development of the COVID-19 vaccine, and a finalized vaccine may be available by the end of the year or early next year, it will still take time to go from development to production, and there will still be major problems to be solved from mass production to mass vaccination.
Thus, it may take until the second half of next year or even the end of next year to overcome the pandemic. This means that the world will continue to be affected by the pandemic through most of 2021. It also indicates that economic activities will remain constrained and that the economy will be in the midst of a modest recovery, with the “V-shaped” recovery that many had hoped for is becoming unlikely.
At the same time, for governments and central banks around the world, the conditions for massive stimulus measures are in danger of running out. The delay in the implementation of the new round of fiscal stimulus in the United States may lead to a “window period” of policy, which will not only affect the economic recovery, but also hinder the capital market which has been boosted by liquidity.
Since the fourth quarter, European and American stock markets have been wandering, reflecting the lack of upward momentum in the face of weakening policy support. As Goldman Sachs notes, the outcome of the U.S. election implies that the scale of the new stimulus package will be much smaller in the future. Other institutions have also made similar judgments. Irene Lauro, an economist at Schroders, said that in the absence of a “blue wave” in the U.S. presidential election, the size and intensity of future stimulus packages are expected to fall sharply.
As the transfer of power is expected to take months, it seems unlikely that any new stimulus will be implemented until the end of the first quarter of next year. As households are affected by the pandemic, this will perpetuate the fiscal gap and reduce the demand from households. For companies, it may cause companies to put on hold their plans to hire, or even increase the likelihood of job cuts. Based on this judgment, Goldman Sachs is not optimistic that the stock market in Europe and the United States will continue to rise in the future, but rather sees more investment opportunities in emerging markets, including China.
In fact, Goldman Sachs’ outlook for each market is mainly based on expectations of future inflation and interest rate changes. The same is true of the stock market and the oil market. Many on Wall Street have been holding out for a steeper yield curve over the past few months. The new model of average inflation expectations introduced by the Federal Reserve will tolerate higher inflation in the long run.
Goldman Sachs’ forecast for the pace of inflation over the next year will also widen the gap between inflation-adjusted real yields, while short-term negative yields become more pronounced. Goldman Sachs expects the 10-Year Treasury yield to rise to 1.3% by the end of next year from about 0.96%.
In addition, they expect the 2-Year Treasury yield to edge up to 0.25% from the current 0.18%. This means that the central bank expects the 2 to 10-year yield curve to steepen by about 30 basis points from its current level of around 78 basis points. According to Goldman Sachs, the real 10-year Treasury yield has been below zero since the end of March, hitting an all-time low of -1.12% on September 2 and now stands at -0.8%. The volatility in real interest rates has been driven primarily by changes in inflation expectations. The five-year real interest rate is -1.2%. Goldman Sachs forecasts that real interest rates will average around -2.1% over the next five years, so the real 5-year Treasury yield will fall sharply further. At the same time, they expect negative long-term real interest rates to fall over the next year.
From the perspective of Goldman Sachs’ outlook on the U.S. bond market, the Federal Reserve will still stick to the loose policy in the future. Under the zero-interest rate, there will be more tendency to give preference to QE and yield curve control to increase the purchase of U.S. Treasury bonds and influence the market interest rate.
Of course, controlling the yield curve can partially replace quantitative easing, which stabilizes market interest rates while reducing the burden of the Federal Reserve’s aggressive balance-sheet expansion. In addition, it would drive up valuations in the U.S. stock market and help stabilize the market. It would also lead to lower long-term interest rates, which would facilitate corporate financing and thus stimulate economic recovery.
At present, Japan and Australia have adopted similar policies and these policies are likely to be the choice for most central banks in the future. The problem with these policies, however, is that it could lead to a big rise in long-term inflation. Although there is no inflationary pressure for the time being in the current economic downturn, the timely withdrawal of unconventional policies in the future will be key to long-term economic growth. If the timing is missed, the world will face a new period of stagflation. That, of course, will be the question for the next three years, but what needs to be addressed now is how to get the economies and markets to recover from the pandemic.
Final analysis conclusion:
International investment banks’ outlooks on equity, bond, and oil markets are based on expectations of an end to the pandemic, economic recovery, and future changes in inflation. Judging from these changes, the pandemic will continue to affect the economy and financial markets next year. With limited conditions for fiscal easing, it is increasingly likely that the Federal Reserve and other central banks will adopt unconventional monetary policies such as yield controls. However, there is still uncertainty about whether they can drive inflation and economic recovery, and the risk of higher inflation in the long term will be the price to pay in the future.
Founder of Anbound Think Tank in 1993, Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing.