While institutional investors are facing an “unquestionably brighter” economic outlook in 2021, challenges such as fluctuations in the U.S. and Canadian dollars still lie ahead, says Karl Schamotta, chief market strategist at Cambridge Global Payments.
In terms of the global growth landscape, he says crowded trades have been fuelled across several asset classes based on an assumption that the U.S. dollar will continue to decline this year. However, that decline isn’t set in stone.
“If the dollar pops because of economic shock or a resurgence in financial instability, it could wreck assumptions that are currently baked into bond yields and equity markets. If I were looking at this as an investor, I’d be conscious of assuming that the dollar will continue to fall and that it’s going to continue to provide lift to emerging markets and commodity prices.”
And while markets have long seen a Joe Biden presidency as positive, Schamotta says the risks stemming from tomorrow’s U.S. Senate runoff elections in Georgia have been somewhat underappreciated. Democrat victories could increase the likelihood of larger and more significant fiscal stimulus, which could also drive a downgrade in assumptions around Federal Reserve stimulus.
“The Fed would be in a position to provide less stimulus than it might otherwise and that would also help to put more weight behind the reflation trend that came through in September through November 2020. There could be a situation in which inflation expectations move up further and that could put pressure on overall asset prices globally.”
Schamotta says investors should also consider the value of the Canadian dollar, which is now correlated more closely with the S&P 500 than with oil prices and that any turbulence in the global financial system could trigger volatility.
“Investors should understand that the world now sees Canada as a leveraged bet on growth and it’s well understood that Canada is a borrowing nation and dependent on global financial conditions. They’ll want to buckle their seatbelts because it’s going to get pretty rough out there. Regardless of whether we see growth or not, movement in the Canadian dollar is likely to be amplified.”
And while vaccine rollouts and the presumed subsequent relaxing of social-distancing restrictions later this year are fuelling a “big bump” in demand for future spending in the first part of 2021, he says the economic effects of the coronavirus pandemic will continue to linger. One particular challenge is that if 2020’s liquidity crisis evolves into an insolvency crisis, where businesses go bankrupt as they formalize the economic weakness of the previous year.
“You can expect to see a second wave of economic destruction if that happens and we could see households suffer quite a bit. The withdrawal of government stimulus just as the economy recovers is going to put us into a very dangerous spot and that’s going to be the key question investors will have to navigate: whether the brighter long-term expectations are enough to anchor and stabilize us in the near term.”