We can of course debate the impact of the Pandemic Emerging Purchase Program (PEPP) (not to mention the tiering on the targeted longer-term refinancing operations – TLTRO – programmes) on narrowing intra euro area spreads and providing liquidity. But in essence, the European Central Bank (ECB) action was focussed more on maintaining the ‘supply’ of credit, not the cost of credit (which was admittedly already very cheap) – maintaining ‘favourable financing conditions’. Furthermore, the persistent weakness of eurozone inflation (forecast for 2023 at just 1.4%), suggests that further accommodation or an unexpected pick-up in demand is needed for ‘current’ monetary settings to be appropriate.

Our central viewpoint of differentiation is the dominant factor in this debate – and by extension the fact that the global capital account is more important to pricing than the current account. For example, many argue that printing dollars and anchoring front end rates can only be negative for the USD. But if, as we expect, the US economy grows at a significantly faster rate than its developed market peers, then the US should generate faster earnings growth (even relative to rising nominal rates), and the US capital account should see significant inflows.

Furthermore, the argument for bonds pricing is more complicated in the near term. We continue to believe that the US growth trajectory drives a higher, steeper US yield curve, at least until we are back near pre-covid levels – at which point the economy will still have significantly more accommodative short rates to sustain growth. However, it is not clear that there will be a global exodus from US Treasuries. In fact, the yield differential has already made holding US Treasuries significantly more attractive than many negative yielding alternatives (even on a currency hedged basis). While many look at twin deficits (which we are also concerned about in the long run), in the near term capital flows are likely to be the dominant driver for US equities and in our view ultimately for the USD. This notion is supported by our Dollar Smile framework, which highlights the convexity of the USD pricing relationship, not just in relation to its safe haven status, but also when its growth outperformance is clear.

Differentiation will be key. European stocks tend to do well when the global economy is strong – they have the highest earnings beta to world growth. However, differentials may distort this correlation for the current recovery – we expect US (growth) stocks to outperform European (value). US banks earnings releases have been very strong so far – some releasing back loan loss reserves, reinforcing capital and growth support further. However, the level of loan reserves in the eurozone was minimal in comparison, as the ECB encouraged banks to run down capital buffers to maintain (in many instances nationally underwritten) loans to the real economy. This, combined with the prospect of a continued flat yield curve (and the hindrances of negative rates), suggests market valuation rebounds should be significantly less pronounced on average in Europe.

Furthermore, while the ECB factors in 0.3PP increase in eurozone GDP this year as a function of the US fiscal stimulus, growth forecasts for this year are being revised lower (German institutes cut 2021 GDP estimate to 3.7%, from 4.7%, just this week). While much of Europe is built on a global export model, it is clear that the Germany for instance (and likely others) are more reliant on China growth (as the correlated slowdown in 2019 attests), than US growth. If China is back to pre-pandemic growth levels, further acceleration from here will be closer to trend (even if y/y comparisons are flattered by the 2020 (Q2?) dip).

Innovation, investment and earnings growth will likely happen (and be dominant) in the US, and thus global capital will flow to the US (bonds, equities and even simply the USD). Nominal GDP growth in the US will be around 10% in 2021 and interest rates are not catching up; in fact, they are lagging by a bigger margin.

The move higher in US yields may be slower and more complex than the rally in Q1, but underlying growth pressures will likely continue to drive prices and rates higher through Q2. US equities will also likely start to outperform again, as the US consumer demand growth accelerates through the year – we expect forward looking earnings estimates from the tech sector to remain very strong. Ultimately, we feel that we are just at the beginning of a boom for US consumption and economic growth and, “ready or not”, that the boom is far from fully priced.