Key investment themes and risks

The key themes and risks our House View team expect to drive financial markets.

Rapid economic recovery 

2020 will go down in history as the year of COVID. Because of the pandemic, last year will also have seen the steepest declines in GDP in the post-war period. 

There are still significant uncertainties and although 2021 is likely to be linked directly with the virus once more, the dominant feature of this year should be a strong and lasting economic recovery (Figure 1).

Figure 1. 2021 and 2022 should both see strong global growth
Country variations, but pre-COVID trends could be regained next year
Figure 1. 2021 and 2022 should both see strong global growth
Source: Aviva Investors, Macrobond as at 26 March 2021

The exact path to, and shape of, that recovery will be determined by transmission patterns of the virus itself (including variants) as well as by the extent of progress of the various vaccine programmes that are currently being undertaken around the world. Initial waves of the COVID virus a year ago had a similar impact in most developed nations, but subsequent waves have been more varied and there may well be some significant differences in the experience across countries going forward. 

Nevertheless, our central scenario envisages a globally coordinated economic upswing in 2021. In fact, despite renewed lockdown restrictions – which affected activity in some places in the last three months of 2020 and are likely to do so again in the first three months of this year – that revival is essentially already underway on a global basis. World GDP has grown each quarter since the middle of 2020, albeit at a slowing pace. 

But if economies reopen significantly, as we expect, then Q2 (especially) and Q3 this year should see some very rapid growth rates of GDP in the major nations (Figure 2). Several economies will regain pre-COVID levels of activity this year, including the US, while others should pass that mark early in 2022.

Figure 2. Some areas of COVID-related weakness in Europe in Q4 & Q1
Quarterly GDP growth, actual and projected
Figure 2. Some areas of COVID-related weakness in Europe in Q4 & Q1
Source: Aviva Investors, Macrobond as at 26 March 2021

On present trajectories and with continuing policy support, it is possible that a number of countries will return to pre-COVID trends by next year, something that seemed highly unlikely just three months ago. Forecasters have been upgrading growth projections in recent months, and we are no different, once again pushing our projections above consensus. 

In our central scenario world GDP is projected to grow by almost seven per cent in 2021 and a further 4.5 per cent the following year. Growth is also robust in each of the alternative scenarios this year (and almost identical to the central case in 2022) reflecting diminishing uncertainty regarding the general macroeconomic outlook. 

The key to delivering this rapid pace of recovery is both the success of vaccine roll-out and subsequent reopening of economies, alongside continued fiscal and monetary support (see subsequent themes below). With large amounts of “excess” savings built up by households during the pandemic, there are risks to the upside (see risks section below for more). 

The backdrop of rapid global growth should continue to be supportive of risk assets in general, although there are likely to be important differences within asset classes, particularly as we expect longer-term interest rates to continue to move higher (see Market Outlook section for more details).

Fiscal fundamentals

The traditional fiscal orthodoxy that has dominated the last three decades has been called into question by events of recent years. The global pandemic has all but cemented the notion that the old rule-book is no longer relevant in most places. 

The fiscal assistance that is still being provided during the COVID crisis is massive and unprecedented (Figure 3). It has also been essential, in our view, helping to avert a far more damaging catastrophe. 

Figure 3. Public borrowing has soared in 2020 & will stay high in 2021
Government borrowing as a per cent of GDP, 2020
Figure 3. Public borrowing has soared in 2020 & will stay high in 2021
Source: Aviva Investors, Macrobond as at 26 March 2021

The principles have so far been quite simple: shutdowns are necessary to stem transmission of the virus; organisations would quickly go bust and jobs would be lost forever if incomes that had previously been earned are not replaced; the government must step in to do just that, absorbing the risks that the private sector cannot until a time that they no longer require public sector financial life support. 

As the IMF and several other bodies have continually pointed out, one of the biggest risks to recovery is the premature withdrawal of fiscal support. Particularly in the light of what are now generally accepted as fiscal policy mistakes in the wake of the GFC, countries are more likely to err on the side of fiscal benevolence than in the past. OECD studies and forecasts show that many of its members will see public debt increase by 20 per cent of GDP or more over the next two years (Figure 4). 

Figure 4. Public debt burdens have increased significantly
IMF estimates for increase in public debt as a per cent of GDP in 2020/21
Figure 4. Public debt burdens have increased significantly
Source: Aviva Investors, Macrobond as at 26 March 2021

In times past, the priority for most governments would have been to reduce debt burdens as soon as possible by paring deficits or even trying to run surpluses. Rules of thumb about responsible metrics for public debts and deficits were an indication of the prominence of fiscal discipline. It continues to some extent in certain quarters, but in most places, fiscal policy is likely to be used for an extended period of time to support aggregate demand and to try to improve the supply-side as well. 

The need for much of the direct fiscal support should diminish automatically. But countries are using the COVID reset, alongside the more enlightened attitudes towards fiscal policy, to rewrite the policy agenda. 

The US, for example, after passing the recent (COVID) stimulus programme, is quickly refocussing on a potentially huge and ambitious public spending package. 

Europe’s fiscal response has not been as large as in the US, but has still been impressive, with the establishment of the Recovery Fund a very important step. 

But everywhere, traditional parameters and targets of fiscal policy are changing. In general, we seem to be evolving from support to stimulus. 

Some is reasonably conventional, albeit overlooked for several decades – infrastructure expenditure for example, but even here there are important changes such as increased emphasis on the green agenda and digital revolution. 

But some is different: countries are adopting or considering fiscal initiatives in new arenas, reflecting novel societal objectives in areas such as climate, diversity and inequality. Of course, there are some overlaps with earlier initiatives, but there are new directions here too. 

Above all, fiscal tools seem to be reasserting themselves as key policy weapons, having lain in the doldrums for several decades.

Monetary policy reboot

The largest central banks around the world appear all to be reading from a similar script, putting great emphasis on their intention to maintain extremely supportive monetary policy for an extended period of time. There is always room for some differences of interpretation in judging what exactly that means. 

Most central banks now seem keen to put greater stress on state-contingent landmarks, rather than rely solely on those which relate to time. Nevertheless, financial markets have continued to try and translate any forward guidance into date-specific deadlines. 

After any economic downturn there is always much conjecture about the appropriate timing for the first touch on the policy brakes, although it is usually a more appropriate metaphor to think in terms of lifting pressure gently from the accelerator. 

Given the extraordinary range and size of policy support measures – monetary, fiscal and other – put in place during the pandemic, that is especially true today. This has not been a “normal” cyclical downswing and it will not be a normal recovery phase either. 

The unique nature of present circumstances, along with the ongoing uncertainties about both the virus itself and the post-pandemic world that it has produced, mean that monetary policymakers everywhere will tread even more carefully than usual when they eventually start to exit from the extreme stimulus policy stance. Financial markets are just starting to query the exact timing, but have largely accepted that there will be minimal changes in the short run (Figure 5). 

Figure 5. Financial markets expect central banks to stay relaxed
Policy rate expectations in the major developed regions (OIS)
Figure 5. Financial markets expect central banks to stay relaxed
Source: Aviva Investors, Macrobond as at 26 March 2021

The timing (and eventual degree) of any decisions that are made in coming years will also be fundamentally influenced by the adoption – explicit or implicit – of a new monetary policy regime in many key geographies. 

The Federal Reserve (Fed) in the US has been at the forefront of these changes, unambiguously adopting an average inflation targeting (AIT) policy. Essentially, this will allow the Fed to balance inflation undershoots (more common recently) with intentional inflation overshoots. 

Other central banks have not yet been as bold, but are clearly moving in a similar direction – the ECB, for example, is expected to adopt something comparable at the conclusion of its strategic review in September this year. 

Arguably, it is other countries which have greater need for a more “pro-inflation” stance as it has been they, rather than the US, that have been least successful in achieving an inflation target (typically two per cent), often undershooting it by some margin in recent years (Figure 6). 

Figure 6. Inflation has largely been below target since the GFC
Core inflation in the major nations
Figure 6. Inflation has largely been below target since the GFC
Source: Aviva Investors, Macrobond as at 26 March 2021

In our view, this represents a major transformation in the way in which monetary policy is conducted, perhaps the most important since inflation targeting became the norm in the 1990s. While not yet certain, it could change the inflation and policy landscape fundamentally.

This monetary policy reboot, as we have termed it, effectively gives license to the holders of the key monetary policy levers (independent central banks) to “run economies hot”, or at the very least hotter than they would have done in the recent past. Then, financial markets would have expected above-target inflation to have been met promptly by tighter monetary policy. They might even have tried to anticipate it. Now it is less clear, and the result is likely to be higher recorded inflation on average which, in turn, should probably be reflected in higher inflationary expectations. These have risen markedly since the middle of last year (Figure 7). 

Figure 7. Breakeven inflation rates have risen, especially in the US
10-year market breakeven inflation rates
Figure 7. Breakeven inflation rates have risen, especially in the US
Source: Aviva Investors, Macrobond as at 26 March 2021

We should point out that, in the light of the inflation experience of recent years, this does not automatically imply that dangerous risks are being taken with inflation. Rather it reflects the monetary policy regime attempting to keep up with modern circumstances. A cynic might point out that there have in the past been instances of monetary principles changing – late – to reflect the previous regime rather than the current one. That seems less likely in today’s low-inflation world. 

Global strategic competition

The Trump period in office was characterised by a confrontational approach on most issues. 

In the international arena, the final two years were largely defined by the deliberately combative attitude to relations with China. Tariffs were simply the weapon of choice. The justification underlying this embraced a number of well-documented grievances against China, including intellectual property theft, several other deeply questionable corporate practices as well as more general objections regarding their human rights record and methods employed to assert their economic and political might on the world stage. 

Hopes that the incoming Biden administration would lead immediately to a rapprochement and a more harmonious relationship between the two superpowers always looked far-fetched. As vice-president in the Obama administration, Biden had already contributed significantly to a hardening of attitudes towards China, including in his direct relationship with Xi as his opposite number. 

Although Trump, as always, put his own peculiar slant on things, arguably he was building on some of those foundations. Equally, while Biden and the Democrats were critical of many of Trump’s ways, it now seems clear that there will be some continuity of effort in confronting China head-on as they attempt to at least shape the form of China’s place in the new world order as the country becomes ever-more significant (Figure 8).

Figure 8. China is moving to top spot in the global GDP rankings
China GDP as % of US GDP
Figure 8. China is moving to top spot in the global GDP rankings
Source: International Monetary Fund via Bloomberg Economics as at 16 March 2021

The first set-piece event between Chinese officials and those from the Biden administration in Alaska in March shocked people out of their comfort zone and injected a note of realism. There were some fiery public exchanges right from the start with both parties explicitly highlighting their perception of the other’s shortcomings. Both were keen to assert their strength – to each other, to their home audiences and to other countries. 

There are echoes here of the old relationship between the two major nuclear superpowers in the 1970s and 1980s, when the US and the Soviet Union were engaged in the Cold War. Relations were often strained, there were many flashpoints in a variety of spheres, yet a form of co-existence and diplomacy was established. 

The comparison can only be stretched so far as it is now clear (although it was not so obvious at the time) that the Soviet Union was in decline, whereas China today is inexorably on its way up. But just as direct conflict was avoided in the past – even if sometimes quite narrowly – it is not unreasonable to conceive that China and the US will find a way of co-existing. 

The complex relationship between the two nations is of course the most important in the world today. But in some ways, it is simply the biggest example of the global strategic competition that looks set to shape international relations – political and economic – in coming years. 

It is not just about China and the US. Most recently the EU has imposed sanctions targeting the China elite in protest over alleged human rights abuses. That these actions have been supported by the UK, the US and Canada illustrates that – in contrast to much of the Trump era – there may be more of a multilateral approach to future relations with China. China has not held back from defending its own position with colourful and forceful language, but this is often how international diplomacy works. 

It is to be hoped that a more coordinated approach from Western democracies will help the transition of China proceed more smoothly and in a manner that is more in line with international conventions and practices. How global political influence settles will be critical, but also crucially important in the world of commerce, will be technology and the digital domain.

Climate change policy

The COVID reset has presented an opportunity for many countries and supra-national organisations to reframe the debate over climate change policies (and several other issues too) as they attempt to define more precisely the agenda for progress. 

Bodies such as the IMF and OECD have made very deliberate efforts to highlight the importance of countries redoubling their efforts on climate change mitigation as economies recover following the pandemic. 

This will inevitably be a multi-year, perhaps even multi-decade task. But change needs to start as early as possible. 

The pick-up in momentum behind the green agenda in general and climate change in particular that began last year has continued in early 2021 and suggests that some meaningful policy initiatives will be introduced this year. 

It is widely hoped – expected even – that public policy in these areas will help inspire a genuine “build back better” approach, but there is clearly a way to go. Bloomberg estimates that of the $13 trn of government support and stimulus so far pledged under COVID-related initiatives, just under $1 trn (7 per cent) has been directed to schemes aimed at reducing greenhouse gas emissions or aiding climate adaptation, less than the total dedicated to carbon-intensive sectors (Figure 9). By contrast, very little if any of the stimulus after the GFC could be classified as green. China’s recent five year plan was especially disappointing, revealing no additional commitments to reducing their reliance on coal.

Figure 9. EU is a key driver of the green agenda
COVID-19 stimulus approved ($bn)
Figure 9. EU is a key driver of the green agenda
Source: Governments, media reports, BloombergNEF as at 26 March 2021

The key set-piece events coming up that should push forward on climate change policies are the climate leaders’ summit in April, the G7 meeting in June and finally COP26 in Glasgow in November. 

But things are already changing quickly. The number of carbon pricing systems (taxes or emissions trading schemes, ETS) has tripled over the last decade, covering almost a quarter of global greenhouse gas emissions (Figure 10). In this year alone, Carbon ETSs are up 30 per cent and are expected to continue to increase. 

Figure 10. Number of carbon pricing schemes has tripled
Share of global GHG emissions covered by carbon pricing initiatives
Figure 10. Number of carbon pricing schemes has tripled
Source: World Bank, “Carbon pricing dashboard,” accessed 22 January 2021

Carbon prices are rising too: in Europe it has moved above €40/tonne in 2021 having fluctuated around €20 to €25 over the last three years (Figure 11). The most important recent development has been the launch of China’s ETS. Although initially aimed at encouraging power plants to document and record emissions, rather than constrain them, the very fact that China is engaging in such schemes is reassuring and something that can be built on in the future.

Figure 11. Carbon price has risen significantly in 2021
EU trading: indicative carbon price
Figure 11. Carbon price has risen significantly in 2021
Source: Aviva Investors, Macrobond as at 26 March 2021

Many other nations have committed to net-zero targets by mid-century, together amounting to more than 65 per cent of emissions and 70 per cent of the global economy. 

Another crucial recent change, in the wake of their election, has been the US rejoining the global effort. The appointment of John Kerry as special climate envoy has raised the prospects for a greater role of climate diplomacy between nations, most importantly, the US, China and Europe. 

But it will not be smooth sailing. Many subjects will need to be addressed at the international level including the thorny issues of international carbon markets and border adjustment mechanisms – aimed at levelling the international playing field on carbon prices.

Climate change policies are fundamentally changing the relative attraction of different types of commercial activities. Costs will rise in many of the most polluting sectors, energy efficiency drives will become more common and the public sector will benefit from fiscal revenues and be expected to foster innovation and contribute directly via a range of energy, transport, buildings and water infrastructure investments. 

Green projects, for example, are at the heart of the European Commission’s €1.85bn recovery plan (Figure 12). The transition to a low carbon world can be shaped by public policy. But ultimately it will be private sector decisions and actions that change the landscape. Among the more obvious areas are electric vehicles, energy-efficient buildings, and green finance. 

Figure 12. Recovery fund to boost green agenda
30 per cent of overall funds directed towards climate change
Figure 12. Recovery fund to boost green agenda
Source: Baker Mackenzie as at 26 March 2021

Digital regulation and taxation 

The increasing digitalisation of business is leading to ongoing reform of national and international rules relating to tax and regulation. 

While attempts are being made to reach some sort of international consensus, a number of countries are looking at the possibility of unilateral actions instead or as well. There is a tension between establishing a unified and consistent set of internationally acceptable guidelines and allowing national champions to flourish in a fair and competitive manner. Although these issues affect all areas of commerce, they are especially convoluted in the digital arena. 

Taxing and regulating international businesses have always been areas of extreme complexity and dispute. Increased globalisation in the post-war period has contributed to capital becoming exceptionally mobile internationally, able to respond quickly to differences in incentive structures around the world, especially to different tax and regulation regimes.

Now the debate is focussing on impacted sectors and this could have important ramifications for those and many other connected areas. Change is happening fast, and policymakers are struggling to keep up. 

There is a danger of arbitrary, hurried or piecemeal approaches that could disrupt affected industries significantly. Moreover, there is also a risk that policymakers move away from sound principles because of political expediency. 

What does seem clear is that organisations with a significant digital or on-line presence will face heightened scrutiny and greater intervention from competition authorities. They will also be under growing pressure to comply with increasingly detailed consumer protection laws.

The international effort has been centred on the OECD, where momentum behind efforts to establish a meaningful agreement on a digital tax has picked up significantly this year, largely because the new US administration is now more fully committed and involved. 

Perhaps as importantly, key players outside of the OECD (India and China) have also signalled a willingness to comply with any solution negotiated at the OECD forum. Confidence is growing that an understanding could be reached (in principle) by the summer. 

A number of issues are outstanding in both Pillar I (redistribution of tax revenue) and Pillar II (increased revenue from minimum taxation). For example, on Pillar I, the US will push for a broader scope so as to capture more companies than just the large US tech firms. Europe by contrast seems to favour a more limited scope, which would shield many of their national tech champions. 

Preliminary estimates from the OECD are that their proposals could increase global corporate income tax (CIT) revenues by between $50bn and $80bn (Figure 13). But the key point is that compromises seem to be within reach and both the US and EU see advantages in getting a deal done. 

Figure 13. Overview of global tax revenue effects from the proposals
Estimates based on illustrative assumptions on the design and parameters of Pillar One and Pillar Two
Figure 13. Overview of global tax revenue effects from the proposals
Source: OECD as at 26 March 2021

If a global solution is found, the EU intends to follow up with an independent EU scheme that is consistent with the global agreement. If negotiations at the global level fail, the EU intends to push ahead with its own scheme, which, in this scenario, would stand a good chance of being adopted and implemented. Individual member states have already begun to impose their own schemes. Last year France imposed a three per cent levy applied on the revenues earned in France by international tech giants.

It is difficult to generalise on digital tax and regulation as these areas are often characterised not only by abstruse levels of complexity, but also by abstract concepts and elusive definitions of activities or processes. Designing appropriate and workable solutions to tax and regulation is therefore not an easy task. But for the first time in a while, there may be some workable solutions within reach.

Risks

Excessive inflation/boom (bust)

Headline inflation rates can and have always been buffeted around by one-off factors. Energy price spikes and collapses have been regular offenders, and these will have a notable impact again in 2021. Food and house prices, mortgage rates and tax changes have also been important in the past. 

But unless these usually transient drivers lead to significant second round effects – altering behaviours and expectations – they are often more noise than signal. 

Underlying inflation is more fundamental, reflecting instead the balance between supply and demand in a true macro-economic sense. In market economies, excess demand leads to rising inflation and vice versa. 

Given the experience of the last 20 or 30 years in most developed economies, this fascination with inflation may seem like a mania-like obsession to many. But before that, inflation had been the main adversary, leaving a trail of economic loss in its wake (Figure 14). It was these disasters that led directly to greater independence for central banks and to inflation targeting regimes. By and large, history will judge this to have been a successful endeavour.

Figure 14. Inflation was the main macro problem in the past
But the long secular decline is probably over
Figure 14. Inflation was the main macro problem in the past
Source: Aviva Investors, Macrobond as at 26 March 2021

But it is possible that this success – alongside the impact of the virus episode (and before that the Global Financial Crisis) – might have led to a degree of complacency about inflation as yesterday’s enemy. 

It is widely accepted that there are significant negative output gaps today (Figure 15) – excess supply in other words – and that is, as it always is, a deflationary impulse for as long as it remains in place. However, they are only ever estimated and there is a risk that anticipated strong post-COVID recoveries lead to a resurgence of demand, pushing it above supply. 

Figure 15. G7 countries, output gap, IMF WEO, estimate
Currently negative, but could close fast
Figure 15. G7 countries, output gap, IMF WEO, estimate
Source: Aviva Investors, Macrobond as at 26 March 2021

There is a potentially rich combination of factors lining up which could move inflation unexpectedly higher: policymakers are explicitly adopting an increasingly pro-inflation stance, monetary and fiscal policy is in maximum stimulus mode and suppressed spending could return more rapidly. In addition, the supply-side of economies may have suffered permanent damage from the pandemic, coming on top of mounting evidence of long-term secular demographic trends that could weaken supply capacity. 

We may not see a return to the inflationary booms of the past. But even a modest reappearance could force grating policyinduced bust. The market implications of this are discussed further in the Market Outlook section.

Fiscal sustainability 

The COVID crisis has resulted in sharply higher budget deficits around the world. As economies recover, those deficits will narrow automatically, but not before public debt burdens rise considerably. 

In most places, a more relaxed stance is being adopted towards these increases and to fiscal largesse in general. Debt and deficit dynamics are reasonably well understood, with sustainability depending on the relationships between key numbers including the initial debt ratio, primary balance, the average rate of interest paid, the rate of GDP growth and the rate of inflation. These allow for a multiplicity of possible equilibria consistent with sustainability. 

Among the most important is the rate of interest, meaning that the recent rise in sovereign bond yields has led to some questions being asked about whether additional debts are manageable (Figure 16). Another key variable is inflation: a higher rate might appeal to some as means by which to erode the real value of higher debts. But any such development would presumably push interest rates up too, potentially to unaffordable levels.

Figure 16. Recent rise in bond yields raises borrowing costs
10-year sovereign bond yields
Figure 16. Recent rise in bond yields raises borrowing costs
Source: Aviva Investors, Macrobond as at 26 March 2021

Amended conventions are probably appropriate today, but the fiscal algebra still has to work. And even with attitudes (and markets) changing, this may prove more of a challenge to some countries than others. 

It is a cold truth that those nations with more delicate fiscal balances to begin with, or those with less secure reputations, are more vulnerable – changes in key metrics could push them onto unsustainable paths quickly. High debt levels can be managed – Japan has shown that. But low, or negative, bond yields have helped enormously too and not every country will be able to rely on them. 

Many emerging market economies have no such luxury, so financial markets effectively impose some form of fiscal discipline on them. If they choose to – or are forced to – run deficits that are considered excessive, they will be punished. 

Even some developed markets can fall victim to such dynamics – it wasn’t that long ago that Italy looked to be at risk of a fiscal disaster (Figure 17). Any increased risk premium demanded by markets can quickly push countries onto an unsustainable fiscal path. The COVID crisis should pass, but there is a risk of some fiscal glitches in its wake.

Figure 17. Fiscal risk rose sharply in Italy in 2018/19
Italy 10-year yield spread over Germany
Figure 17. Fiscal risk rose sharply in Italy in 2018/19
Source: Aviva Investors, Macrobond as at 26 March 2021

Pricing for perfection

We remain optimistic about the ability of the global economy to recover from the COVID pandemic in 2021. Policymakers have been responsive to the crisis, supporting households and businesses. 

Those same households and businesses shown considerable resourcefulness in adapting to abnormal circumstances, limiting the extent of the negative hit from lockdowns. The suite of effective vaccines currently being deployed are increasing visibility about the future and argue for a marked reduction in uncertainty. 

Our central scenario for growth is still above consensus across the major economies. However, we are conscious that the expectation for a rapid recovery in global growth in 2021 is almost unanimous amongst market participants. 

Similarly, expectations that a favourable growth backdrop will support risk assets, including a rotation to cyclical and value stocks, as well as commodities, high yield credit, emerging market currencies and other cyclical asset prices, are widely held. 

These expectations may have already been well discounted in some assets. The succession of encouraging news about effective vaccines last November led to significant rallies in many risk assets, reflecting the growing belief that a path to the end of the pandemic had become much clearer. The setbacks over the winter have, so far at least, resulted in only fairly modest corrections in quite a narrow range of markets. 

As a result, some parts of the market may stil be effectively “priced for perfection”, when that outcome is rarely what actually happens. Many financial assets still appear expensive on conventional valuation criteria when there is still at least some doubt about the exact path from here. 

More generally, in recent years periods of market exuberance have often been followed by an extreme, but short-lived spike in volatility stemming from market corrections. The trigger for such corrections has been highly unpredictable, but any emerging evidence of possible overheating in the recovery phase is a possible candidate.

Longer-term scarring 

The extraordinary and unprecedented range and amount of policy assistance that has been put in place during the COVID crisis has, in our view, averted an even more damaging downturn and one which could quickly have become self-perpetuating. 

Among the most important has been the array of direct support measures, such as furlough payments and grants to companies who have not been able to operate as normal. Collectively, these represent massive financial transfers from the public sector to the private to replace otherwise lost incomes or revenues and to allow some corporations to continue to meet costs that would otherwise swiftly have pushed them into bankruptcy. 

But putting large swathes of the economy into, effectively, suspended animation, is not riskless. Eventually, economies will reopen fully and the various support schemes will be gradually withdrawn. It is only at that time that the extent of any permanent damage will become apparent. 

It is a sad truth that although government schemes aim to tide people and companies over until better times return, not all will be able to do so. Some firms will go under, others will reduce the scope and size of their operations. Some jobs will not be there to return to, and unemployment will, inevitably, rise. GDP may be permanently lower than it would otherwise have been (Figure 18).

Figure 18. There will be some lasting damage from COVID
Estimated GDP in Q4 2022 compared with Nov 2019 projection
Figure 18. There will be some lasting damage from COVID
Source: OECD Economic Outlook database; and OECD calculations as at 26 March 2021

The extent of this damage is unknown but could be significant. Using the UK as an example, the Office for Budget Responsibility (OBR) has estimated that GDP could be two per cent lower indefinitely because of such effects. That is an immense permanent economic loss, if it proves accurate. 

Moreover, it is not a binary issue – whether there is a job to resume or a company to restart. There is a range of possible outcomes, even in individual cases. The COVID experience is widely expected to have altered some behaviours profoundly, especially in areas characterised by close social contact. 

Again using the UK as an example, the pattern of furlough has varied considerably across different sectors (Figure 19). It may take far longer, for example, for international or business travel to return to “normal”; working practices may have changed permanently, meaning less need for as much office space or public transport and lower demand for any attendant services. Fewer hours may be made available to workers in such an environment, even if only temporarily. 

Figure 19. Furlough has varied considerably across sectors
Percentage of UK jobs furloughed by industry, February 2021
Figure 19. Furlough has varied considerably across sectors
Source: Aviva Investors, Macrobond as at 26 March 2021

All these factors will imply lower incomes, reduced spending and lower output. Even if resources can be redeployed in other areas, transitions are not frictionless and not painless. If permanent damage is worse than feared, the supply-side hit to economies could have damaging knock-on impacts on long-term growth.

COVID mutations

Mitigation of the spread of COVID-19 both within and across nations around the world has been complicated by the emergence of a number of variants of the virus. 

Virus mutations are inevitable – it is what viruses do – and had been widely expected. However, the speed of the arrival of variants which potentially undermine vaccines has come as a surprise to many experts in the field who previously had been reassured by the slow pace of mutation. 

Figure 20 shows an example of mutation dynamics of the virus in Denmark, as that country has undertaken much more detailed genome sequencing than many others. The chart shows just how quickly the UK variant (B.1.1.7) became the dominant one for newly confirmed cases once it was first established last December. The other grey bands show earlier more minor variants of the original virus. The trial data so far is limited, but the most recent vaccines to report their results have been able to compare efficacy between regions where different variants are dominant. 

Figure 20. Mutation dynamics change very quickly
The UK-originated variant is now dominant in Denmark, for example
Figure 20. Mutation dynamics change very quickly
Source: Aviva Investors, Macrobond as at 26 March 2021

The picture these studies paint is mixed. While there have been material falls in the protection against symptomatic infection, the protection so far against severe illness appears less impacted. Given the relatively low proportion of infections which develop severe illness, the statistical power of these limited number of observations isn’t enough to give complete confidence. This raises the prospect of vaccination programme being extended further with either third doses or maybe booster shots with updated vaccines a strong possibility in the European autumn.

When thinking about the potential for further mutation, the convergent evolution currently being observed, with many of the mutations which are causing concern occurring independently around the world, does suggest though that this race against viral evolution won’t be as challenging forever. 

These common patterns suggest the strongest advantages that single mutations can confer have been seen and evasion of updated vaccines would be a slower process. While far more is now understood about virus mutations and their possible consequences, it is obviously a constantly changing environment. Despite increased awareness and monitoring, it is quite plausible that the emergence of mutations – including of potentially more dangerous variants – could oblige authorities to impose more stringent lockdown restrictions or to retain containment measures for longer than originally planned. Any such development would prolong and deepen the economic hit, oblige governments to provide ongoing fiscal support and increase further risks of permanent scarring. The economic recovery would be slower, weaker and less certain.

Read more of the House View

Executive Summary

A summary of our outlook for economies and markets.

Macro forecasts: charts and commentary

Our round-up of major economies; featuring charts and commentary.

Global market outlook and asset allocation

What our House View means for asset allocation and portfolio construction.

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Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment. 

In Europe this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178.. In France, Aviva Investors France is a portfolio management company approved by the French Authority “Autorité des Marchés Financiers”, under n° GP 97-114, a limited liability company with Board of Directors and Supervisory Board, having a share capital of 18 608 050 euros, whose registered office is located at 14 rue Roquépine, 75008 Paris and registered in the Paris Company Register under n° 335 133 229. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

 In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva Investors’ affiliate is a subsidiary of Aviva plc, a publicly traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606