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Economists’ eye: A macro view of 2021

If 2020 threw us some curveballs, what does this year have in store? Insider Engage rounds up the key issues for 2021 cited by the world’s top economic brains

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As 2021 begins, there are two reasons why UK businesses might be feeling more cheerful about the economy: a Brexit deal was (finally) struck on Christmas Eve, and the UK has approved a second vaccine for Covid-19.

But hold your horses for a moment. Much of the detail of the Brexit agreement’s impact on financial services has yet to be worked out. Also, a spike in cases of Covid-19 – thanks to a more infectious strain of the virus - has forced a new set of lockdowns across several European countries.

Elsewhere, with President-elect Joe Biden set to take office on 20 January, the US is gearing up for change, too. Its relationship with China will be of particular interest to international investors.

The environment, and our impact on it, will also be on the agenda in 2021 as the US rejoins the Paris Agreement and the COP26 UN Climate Change Conference has been rescheduled for November.

As these and other stories develop, Inside Engage has gathered views from economists and strategists to find out what should be of interest to insurance CIOs, CFOs and financial directors going into the new year.

Global vaccine

The UK has started to administer vaccines from Pfizer/BioNTech and AstraZeneca/Oxford to protect people from the Covid-19 pandemic that ravaged the globe last year. However, vaccinating the rest of the world will take a long time – and could face resistance from some quarters.

As Simy Prakash, general insurance investment lead at EY, points out, the effects of the pandemic “will continue to be a key risk to insurers’ investment portfolios for 2021”.

“It is worth considering that, even if the vaccines act as a wholesale solution to the pandemic in 2021, the economic impact of the stimulus packages and government support will be felt for years to come,” she adds. “Some industries have been very heavily hit financially and we are yet to see the true impact on certain parts of the economy.”

Scott Thiel, chief fixed income strategist at BlackRock, is more positive.

“The vaccine game-changer is knowing that we are building a bridge to somewhere, an anchor that should help limit longer-term scarring,” he says.

This should benefit the global economy both in the short term – aiding the restart of sectors that have been shut down due to the pandemic – and the long term, by enabling a return to the pre-Covid-19 trend in economic growth.

In the meantime, economic stimulus from central banks and governments could also help create the “bridge” to recovery. In late December, US policymakers agreed another blockbuster package to provide support to individuals and small businesses that continue to be affected by the pandemic.

“[Vaccines] suggest the economic restart can re-accelerate significantly in 2021 as pent-up demand is unleashed,” Thiel explains. “We believe markets will likely be quick to price in a full economic restart given the improved visibility on the outlook.”

Reading rates

As the economic outlook for various economies starts to improve, attention will inevitably turn to interest rates.

The US and UK both cut rates to record lows in the first quarter of 2020, while the European Central Bank kept its interest rate at zero throughout the year. However, positive vaccine news led investors to unwind bets on rates going negative in the UK late last year.

In the US, the Federal Reserve has warned rates will remain near zero until 2023 – although this could be challenged if the economy bounces back strongly during 2021 and inflation pushes through the Fed’s 2% target.

Capital Economics believes the pandemic “may have been the final nail in the coffin” for inflation targeting by central banks. With national debt loads having expanded rapidly to finance Covid-19 support packages, central banks may become more tolerant of inflation.

A return to a “normal” monetary policy environment is one of the biggest risks to the recovery if it happens too quickly, argues Capital Economics’ group chief economist Neil Shearing.

“The outlook for [2021] has brightened but most countries face a difficult winter and economies will remain dependent on continued policy support,” he says. “While we’re more bullish than most forecasters on growth, we remain of the view that the world’s major central banks will continue to maintain ultra-loose monetary conditions and that real rates remain firmly in negative territory.”

This will keep bond yields down, Shearing says, but there will be some key differences between markets. In the US, for example, inflation-linked bonds could outperform, while the US dollar will likely weaken against other major currencies – in particular “high beta” currencies such as the Australian dollar.

“A challenge for insurers in this environment is the ability to deal with low rates across virtually all major markets,” Thiel says.

This has caused a rethink across the sector regarding their ability to provide guarantees, he explains. In future, investment and product teams will have to work closely together to respond to market changes and maintain the profitability of their offerings.

“In practice, insurers will need to revisit how they construct underlying portfolios to ensure products can meet specific outcomes, combining access to a wider opportunity set with sophisticated hedging and risk management techniques,” he adds.

Raising the tech bar

EY’s Prakash says insurers will be able to find plenty of investment opportunities as 2021 unfolds – although what these are will depend on the specific nature of an insurance company’s balance sheet.

Regardless of the opportunities that arise, Prakash says having the right talent and technology will prove key to harnessing them.

“Many insurers still rely on Excel spreadsheets and manual labour, with limited resources dedicated to investments within the business for mostly historical reasons,” she says.

“However, as investment returns become an increasingly important driver of profitability, it is important that appropriately robust investment frameworks are placed around insurers’ strategies to protect against increasing market uncertainty.”

As 2021 dawns, many of the same risks remain to economic growth, investment returns, and fixed income yields. But with profound changes bedding in during the first few months, investors will have to remain alert and flexible to grab the opportunities as they arise.

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