Stock markets started the new year in spectacular fashion, spurred on by rising expectations of a global economic recovery, US stimulus and a Democratic victory in the Senate.

The FTSE 100 recorded a 6% gain in the first trading week of the year, with strong gains also seen on Wall Street and across Europe, as rising coronavirus cases, and the storming of the US Capitol by a mob of Trump supporters, barely knocked markets off course.

In the US, the Democrats taking control of the Senate after winning runoff elections in Georgia on 5 January – and the subsequent Democrat ‘clean sweep’ of both houses of Congress – means president-elect Joe Biden should have a clear path to put his policies into action.

And that will almost certainly mean more government spending, potentially accelerating economic recovery and inflation in the world’s biggest economy. It also adds more impetus to the bets investors have been taking since November, jumping on the reflation bandwagon and betting the world economy would return to growth in 2021 thanks to Covid-19 vaccines and Biden’s election victory.

It’s also why investors have looked past the short-term impact of rapidly rising Covid cases and the political turmoil in the US, with markets almost unmoved on the day of the Capitol attacks, as the vaccine rollout gathers pace and conditions bode well for a recovery later in the year. Household saving rates are reported to be at record highs, while there is increasing evidence of strong pent-up demand among consumers.

One area of the market which hasn’t fared so well in 2021 to date is US big tech, on fears Biden could hit the likes of Apple, Facebook and Amazon with anti-trust measures, aimed at breaking their monopoly power, and higher tax bills.

Elsewhere, the US yield curve, calculated using the difference in yield between two and 10-year government bonds, is the steepest it has been since mid-2017.

The scenario playing out sees long-term yields rise more quickly than near-term ones as investors look to price in an acceleration in economic growth and interest rate increases. Investors fear being locked into low rates and demand greater compensation for owning longer-dated paper.

This is the bond market’s way of saying an economic upturn, and potentially inflation, could be around the corner.

Though one warning sign is that money markets have ramped up bets on US interest rates rising in 2023, suggesting global stocks could take a hit when the Federal Reserve starts scaling back its support for the economy.

Analysts expect it could signal its intention to do this in June if it looks like the vaccine rollout is going to plan and economic growth is getting back on track. [YF]

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