hero july market commentary

Allianz Investment Management LLC 4Q 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 updated insight on the economic and market outlook for the rest of 2021.

business team talking

Key points:

  • The economy ran into a soft patch late this summer, but the overall outlook remains favorable  

  • Higher-than-expected inflation levels are calling into question the “transitory” view on inflation

  • The Fed is looking to begin unwinding monetary stimulus sooner than anticipated

  • Expecting turbulent markets in the near term, but overall the economy remains in good shape
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Market update: The Delta wave

Volatility within both equity and rates markets has been a by-product of building uncertainty around the path of the economy and expected changes in policy from the Fed. The Delta wave of the virus has brought some challenges to the economic outlook, but not enough to derail the recovery. Mixed economic signals, particularly from the labor market, have presented an unclear picture for the economy in the near term. As a result, equity prices have come off their highs from early September, and interest rates have been mostly under pressure. One thing that is clear is that inflation has been persistently higher than expectations over the summer, and the Fed is beginning to take notice. Both the Core Consumer Price Index and Core Personal Consumption Expenditure Index have climbed to levels we have not seen in decades. The higher levels of inflation are making it difficult for the Fed to ignore and some market participants have called into question the “transitory” view on inflation. As such, we believe higher levels of inflation are forcing the Fed to bring forward their exit strategy from high levels of monetary stimulus. Looking ahead, we expect some clarity for market participants as the Delta wave of the virus subsides and the Fed divulges their plan for tapering the bond purchase program. While the latter is likely to cause some turbulence among risk assets over the short run, we believe unwinding the emergency monetary stimulus measures that have been in place for the last year-and-a-half seems highly appropriate at this juncture.

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Update to 2021 U.S. economic and market outlook

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U.S. GDP 6.00%-7.00%

Following a swift economic recovery out of the gate this year, some near-term headwinds have challenged the pace of growth during the third quarter. Most notably, the Delta wave of the pandemic has delayed plans for businesses to return to the office this fall and likely slowed some expected business travel. In addition, rising consumer prices have clearly taken a toll on consumer sentiment. Lastly, bottlenecks and supply chain issues are contributing to inventory depletion, which has likely delayed some consumer activity, especially for those in the market for a new vehicle. While some consumption measures have been flashing yellow as of late, business survey indicators continue to look strong with purchasing manager indexes well in expansionary territory. The soft patch of economic data from this summer should be short-lived as activity picks up during the fourth quarter, and we ultimately expect U.S. GDP to finish the year in a range of 6.00% to 7.00%.

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U.S. inflation 3.25%-3.75%

The transitory message on inflation from the Fed is beginning to overstay its welcome as the rise in consumer prices hasn’t moderated much. Imbalances of supply and demand have driven inflation well above expectations this year with most of the reopening categories in the goods sectors showing the highest increase in prices. Supply chain issues continue to roil the automobile sector with used vehicle prices up over 30% from a year ago. The Fed and most investors expected the swift increase in consumer prices to be brief, but the current situation is starting to drive up expected inflation measures, with University of Michigan’s one-year-ahead inflation expectation rising to the highest level since 2008. Another factor to note, shelter costs are starting to rise as higher rents and owner’s equivalent rent are reflected in the data. Thus, we have increased our forecast in Core PCE Inflation to end the year in a range of 3.25% to 3.75%. However, beyond 2021, we still currently expect inflation to level off and mostly be transitory.

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Fed Funds 0.00% - 0.25%

A faster recovery this year combined with elevated inflation pressure has forced the Fed to move forward with tapering bond purchases sooner than they would have liked. However, the market expectation that the Fed has to end bond purchases before signaling the possibility of raising rates means that policy rates are not going to come off zero any time soon. We expect the Fed funds rate to remain at zero through the rest of this year and the first rate hike possibly occurring in 2023 depending on how the economy evolves.

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U.S. Rates 1.50%-2.00%

The reflation trade started losing momentum in the second half of this year as technical factors overcame fundamentals, eventually weighing on long-term rates. The 10-year Treasury yield is still up over 40 basis points since the beginning of the year, but well below the high of 1.74% in March. The wall of liquidity created by the Fed’s bond purchase program is one aspect holding yields down, and with taper talk heating up, we expect this technical factor will fade. We think rates are fundamentally too low given the current economic backdrop, and with real yields at historic lows, the path of least resistance for the 10-year yield is higher. Tapering bond purchases from the Fed may be the next catalyst for higher rates, and we are maintaining our forecast for the 10-year yield at 1.50% to 2.00% for year end.

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U.S. Equity 15%-20%

Strong earnings, low interest rates, and the continued economic recovery provided a favorable backdrop for U.S. stocks during the third quarter. However, after reaching all-time highs in early September, U.S. stock indexes struggled to move higher against a rise in Delta variant cases, supply chain concerns, and below-average summer trading volume. A historically unstable market period, headline risk from Washington D.C., and a Federal Reserve projection of stimulus tapering also led U.S. equities to fall from their peak. We believe this disturbance will pass as the economy remains on a strong economic trajectory. While talk of expanded fiscal policy, elevated inflation, and higher interest rates could slow the recovery, solid corporate earnings and strong consumer spending should prevail. This will bring a positive tone to U.S. equities into year-end and allow returns to close 2021 within our projected range.
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Risks to the outlook

While our base case continues to believe that the economic recovery remains intact despite the near-term growth headwinds, we acknowledge that there are several potential risks that could bump us off course. We are still in a global pandemic, and despite our best wishes for life to return to normal, the Delta variant appears to have slowed the economic recovery. However, as we have learned over the course of the last 18 months, the economy is resilient and will adapt as we continue to learn how to live alongside the virus. Investors have been closely monitoring any signals from the Federal Reserve as they appear ready to shift their monetary policy. With the Fed indicating they are likely to start reducing their bond purchases at the end of this year, the probability of a policy mistake increases as they are in the unenviable position of judging the path of economic activity in real time. We know the pandemic has disrupted global supply chains and created supply and demand imbalances, but it is not known exactly how quickly these disruptions can get corrected and to what extent rising wages will lead to a self-reinforcing impact on input costs. We continue to expect interest rates to remain low for some time, but should inflation prove to be more persistent than the Fed has anticipated, they may need to react sooner and more aggressively than the market’s current expectations. This combined with elevated equity valuations could quickly lead to a sharp uptick in volatility and a quick reversal in risk attitudes. On the global front, China’s recent regulatory actions pose risks for global growth and spillover effects as they try to exert their control over businesses and restrict excessive debt levels. We remain positive on the economic recovery, but it is evident that there is no shortage of potential risks that could derail the current growth trajectory.

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The views, opinions and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of the date of publication. 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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