hero july market commentary

 Allianz Investment Management LLC Midyear Market Outlook

Representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets and economic releases such as inflation, GDP, consumer confidence, housing, retail sales and job unemployment news. Here is their midyear insight on the economic and market outlook for the rest of 2021.

business team talking

Key points:

  • The road to economic recovery in the U.S. remains intact while the global economic recovery is beginning to take shape

  • Elevated consumer price pressures are driving uncertainty around interest rates and Fed policy

  • An outcome-specific Fed has specifically tied policy to progress on the labor market

  • The potential of a policy mistake by the Fed is a main risk that market participants are paying close attention to


Market update: Uncertainty expected to pick up

Just as the weather starts heating up for summer, so too has inflation as supply chain constraints and pent-up consumer demand have lifted inflation to multi-decade highs. While our last update was only six months ago, the economic environment has shifted dramatically since the start of the year as vaccination participation and the removal of many pandemic related restrictions have paved the way for increased consumer spending and economic activity. Thematically speaking, our outlook for the remainder of the year is still predicated on a strong economic recovery, steeper yield curve, continued dovish Fed policy, and reflation. Despite some strong economic tailwinds, we do expect some headwinds in the near term. For instance, employment has lagged the recovery with a large gap of jobs to be filled. Additionally, the pace of the recovery is putting stress on supply chains with depleted inventory levels, which is driving up inflation in specific sectors. From a market perspective, equities appear to have fully priced the economic rebound, and any further gains will likely be driven by profit margin expansion. In the bond market, yields have been mostly range bound as the Fed has kept a lid on how much rates can rise. Going forward, we expect uncertainty around the path of inflation and Fed policy to pick up, which could bring more volatility to both interest rates and equity markets in the near term.


Update to 2021 U.S. economic and market outlook

1 Light BulbLight Bulb

U.S. GDP 6.00% - 7.00%

The much-anticipated growth story continues to strengthen as surging consumer demand has paved the way for stronger economic activity in the U.S. Swift progress on vaccinations since the beginning of the year has allowed government officials to relax many of the COVID-19 restrictions that have been in place throughout the winter months. The combination of pent-up consumer demand along with low inventory levels has driven many economic data points to reach record levels. Both survey-based measures in the manufacturing and nonmanufacturing sectors have reached multi-decade highs in recent months. The bottom line is the economic recovery has developed faster and stronger than originally anticipated. As such, we are revising our forecast for 2021 U.S. GDP to 6.5%.

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U.S. Inflation 1.80% - 2.30%

The debate among market participants around the path of inflation has started to heat up as inflationary signals continue to dominate market headlines. Supply chain issues along with elevated economic activity have resulted in upward price pressures in some sectors of the economy. The official message from the Fed is that higher consumer prices will only be temporary until labor market slack is diminished. However, some investors are starting to question how long inflation pressures can be considered temporary if they are expected to last into the following year. Focusing on the Fed’s preferred measure of inflation, core PCE, will likely lag core CPI due to composition, and that gap will likely widen further in the coming months. While we expect inflation to rise above our forecasted range in the near term, we expect core PCE will settle within our range by year-end.


Fed Funds 0.00% - 0.25%

Better-than-expected economic growth coupled with rising inflation pressures has some investors pushing back on the Fed’s ultra-accommodative policy stance. While it may be too early to determine whether upward consumer price pressures are temporary, the Fed appears to be holding the line on policy change until the labor market normalizes. Market expectations for Fed hikes have been pulled forward from what the Fed has been signaling. Despite this, we still believe the Fed is a long way from lifting policy rates, as the reduction of bond purchases is the first order of business from the Fed before rates can be lifted. The discussion on tapering bond purchases will likely pick up in the second half of this year with a decision likely by year-end. Thus, we expect the Fed funds rate to remain near zero for the foreseeable future.

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U.S. Rates 1.50% - 2.00%

The beginning of the year brought on a swift repricing of the yield curve that was primarily driven by higher growth and inflation expectations. Since then, interest rates have mostly traded in a narrow range as the Fed’s conditional policy guidance has kept a ceiling on rate normalization. Going forward, we expect the next shift higher in interest rates will hinge on the Fed starting the process of removing accommodative policies that have been in place since the pandemic started. Recently, the Fed has taken a step in the right direction, albeit small, in committing to wind down their corporate credit purchases. The next step will be reducing the $80 billion of Treasuries the Fed purchases each month and the process toward normalizing interest rates will be underway. As a result, we continue to forecast the 10-year Treasury yield will end the year within a range of 1.50% to 2.00%.

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U.S. Equity 7.50% - 12.5%

Since the end of April, equity markets have trended mostly sideways with some consolidation within certain sectors. Year-to-date, the S&P 500 Index returns have reached the upper end of our range fueled by strong sales and earnings growth during the first quarter. Additionally, a favorable interest rate backdrop has been supportive throughout the recovery. Moving toward the midcycle of the recovery, growth tends to moderate and investors typically begin to look for value, which can be corroborated with the rotation away from growth and into value stocks. Going forward, earnings expansion is likely the catalyst to drive prices higher, but uncertainty around things like Fed policy, interest rates, and taxes pose a threat to the direction of equities in the near term. 

Risks to the outlook

While our outlook for the economy and financial markets remains positive, we do see potential risks to our view that need to be acknowledged. First, we believe that COVID-19 vaccinations worldwide will continue to increase. This could lead to a global recovery that improves trade and benefits to all economies, including the U.S. Any roadblock in logistical distribution, medical support, or vaccine production could create further quarantines and affect our growth projection. Vaccine effectiveness against ongoing virus variants will also be closely watched by market participants, as any significant decline in efficacy would have a material impact on economic and market forecasts. Additionally, we expect a continued low-interest-rate environment domestically to support growth for both companies and households. This environment also provides an incentive for consumers to reduce the savings they accumulated over the pandemic and spend it on goods and services. A rapid increase in interest rates driven by Fed policy shifts could slow consumer spending, dampen growth, and ultimately affect our market return expectations. A third risk to our projection is the rising cost of energy. Increasing gas prices are akin to an additional tax which takes away from consumption and slows economic growth. Lastly, we would be remiss for not addressing the inflation risk to our view. The extent of fiscal and monetary stimulus that has been injected into the economy needs to be handled with the utmost care and control. The Federal Reserve’s objective of letting inflation run above trend carries significant risks. This choice comes at a time when the economy is reopening and growth is expected to be extremely strong. Questions around how long inflationary pressures last, what areas of the economy are more entrenched and persistent, and whether the Federal Reserve can effectively control price levels given their available tools will affect the reopening growth. Any prompted change in Fed policy could reverberate through the economy and markets, and subsequently affect our expectations. We remain positive on the economy and capital markets; however, there are assumptions and risks in any forecast. These are a few we will be tracking closely as the year progresses.


List of definitions

Here are the definitions of the key terms used in this market report.

The views, opinions and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of 06/2021. This document is provided for informational purposes by AIM LLC, a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America. These views may change as interest rates, market conditions, tax rulings and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. This report does not constitute a solicitation or an offer to buy or to sell any security, product, or service. It is not intended and should not be used to provide financial advice as it does not address or account for an individual's circumstances. Consult with your advisor and tax professional before taking any action based upon the information contained in this document. Past performance does not guarantee future results and no forecast should be considered a guarantee. Any investment and economic outlook information contained in this document has been compiled by AIM LLC from various sources, including affiliated entities. AIM LLC takes reasonable steps to provide up-to-date, accurate, and reliable information, and believes the information to be so when provided, but no representation or warranty, express or implied, is made by AIM LLC as to its accuracy, completeness, or correctness.

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