During the third quarter of 2020, children in large parts of the world went back to school, with many entering a classroom for the first time since early spring, when lockdowns started to be imposed on huge swathes of the global population. While the reopening of schools has meant a return to some semblance of normality for many pupils and their families, new rules related to social distancing, face coverings and hygiene have made this new school term unlike any other.

For much of the quarter, financial markets also appeared to have returned to business as usual, resuming the upward momentum with which they began the year before the onset of the pandemic. Global equities, as represented by the MSCI World index, chalked up their best August – traditionally a quieter month for trading – since 1986.1 September, however, began with a rout in technology stocks, whose share prices had soared well ahead of the rest of the market in the prior months, and market volatility remained elevated for the rest of the quarter, meaning that global equities forfeited a large proportion of the gains made earlier in the period.

Equity markets
Total returns, rebased to 100 at 30.09.15

Equity markets

Source: Factset, October 2020.

Investor sentiment was boosted over the summer as economies reopened and hopes grew for the development of an effective Covid-19 vaccine, while markets were further encouraged by a series of positive economic-data releases and the accommodative stance of the US Federal Reserve.


However, beneath the surface, a number of other developments hinted at a more uncertain and fragile backdrop. Global cases of the coronavirus continued to rise throughout the period, with numerous European nations in particular seeing a resurgence, leading to the reintroduction of localised lockdowns. Trade tensions between the US and China continued to escalate, as President Trump announced sweeping restrictions on popular Chinese social media networks, and introduced sanctions against prominent Hong Kong officials following the introduction of stringent new security laws in the region. Meanwhile, although the US labour market continued to rebound, there were increasing signs that the recovery could be slow. By late September, the country had only regained around half of the 22 million jobs lost during March and April.2

US employment
Cumulative change in jobs since September 2016

US employment

Data is seasonally adjusted.
Source: Bureau of Labor Statistics, October 2020.

The level of state intervention, which reached unprecedented heights during the second quarter as the pandemic took hold, continued into the third quarter at a staggering pace. In July, the European Union (EU) agreed on a €750bn recovery fund, noteworthy not only in terms of size but also in the fact that it will be jointly financed by member countries, with liabilities spread across all 27 EU member states.3 The IMF has forecast that rich countries will borrow 17% of their combined GDP in 2020 to fund US$4.2 trillion in spending and tax cuts intended to stimulate economies. In the key markets of the US, the eurozone, the UK and Japan, central banks have already created new reserves of money valued at over US$3.7 trillion this year.4


The simultaneous commitment of central banks to purchase government debt, alongside action from governments in directing fiscal spending to support household and corporate incomes, has been necessary, given the circumstances. The danger is that this will create inflationary pressure. Beyond the near-term impacts, if new monetary policies create a path to inflation, investors could face a very different backdrop to that which they have become accustomed to over the last three decades.

In fixed income markets, the ‘risk-on’ sentiment during much of the quarter meant that returns from UK government bonds were negative. The FTA Government All Stocks Index (gilts) delivered a return of -1.2% over the quarter (+7.6% over the nine months to 30 September), while the JPM Global Government Bond Index (excluding the UK) returned -2.1% in sterling terms for the quarter, with a year-to-date return of +10.0%. Corporate bonds, however, were positive in this environment, with the BofA ML Sterling Non-Gilts Index returning +1.2% for the quarter (+4.6% over nine months).5

Most major equity markets delivered positive returns. Emerging-market equities returned +4.5% in sterling terms over the quarter (+0.6% over the year to date), Asia Pacific ex Japan equities returned +2.3% (-0.6%), while Europe ex UK equities delivered a quarterly return of +1.4% (-0.5% over nine months). Meanwhile, North American stocks returned +4.5% over the quarter (+9.0% over nine months) and Japanese stocks returned +2.4% (+2.3%) for UK investors, while UK equities were the laggard with a return of -2.9% over the quarter (-19.9% over the year to date).6

Gold continued to shine, posting a quarterly return of +6.0% in US-dollar terms, taking its nine-month return to +24.3%. In sterling terms the precious metal delivered +1.7% (+27.6% over the year to date).7

At its September meeting, the US Federal Reserve’s (Fed) Federal Open Market Committee (FOMC) improved its projections for the US economy, forecasting that US output would contract by 3.7% in 2020, compared to its June estimate of a 6.5% decline. The central bank also made no changes to its bond-buying programme (it has been purchasing US$120 billion of securities per month). However, with US Congress having so far failed to agree an additional stimulus package, Fed Chair Jerome Powell acknowledged the fragile nature of the recovery: “More fiscal support is likely to be needed…There are still roughly 11 million people out of work. A good part of those people were working in industries that are likely to struggle.”8

Against this backdrop, the Fed has signalled that there are likely to be no interest- rate increases until at least the end of 2023. It has also indicated that it will not tighten monetary policy until inflation has been higher than 2% for some time.9 This move to pursue an average rather than a fixed inflation target represents a significant shift in the central bank’s approach to managing inflation. As in many other economies, inflation in the US has remained stubbornly low, and removing the fixed target could provide further support for the recovery. With the presidential election approaching, and with neither Democrats nor Republicans making any attempt to subscribe to fiscal prudence, there is a very real chance that the combined impact of monetary and fiscal policy could lead to a sustained acceleration of goods and services inflation.

As the UK’s trade discussions with the EU appeared to reach an impasse over the summer, data showed that the country’s economy experienced a bigger slump than any other major European economy in the three months to 30 June, as GDP declined over 20% from the previous quarter.10 The UK’s large consumer sector, which was particularly hard hit by the extended lockdown, is likely to have been a key factor behind the underperformance. Although the economy has since begun to recover, in July it was still almost 12% smaller than it was in February.11

UK economy
Annual change in quarterly gross domestic product

UK Economy

Figures are seasonally adjusted.
Source: UK Office of National Statistics, October 2020.

Speaking at the Jackson Hole central-banking conference in August, Bank of England Governor Andrew Bailey said he believed the central bank had ample “firepower” to support the UK economy, commenting that the £200 billion bond-buying programme that the Bank had set up in March demonstrated the benefit of being able to “go big and fast” in times of crisis.12 The central bank indicated that it would not tighten monetary policy until it was clear that inflation was returning to target, and has also not ruled out the use of negative interest rates. Bailey also suggested that the Bank might need to start unwinding its quantitative easing programme before it raised rates, in order to ensure it had the capacity to fight the next crisis.

In Europe, the EU’s agreement on a €750 billion European Recovery Fund, reached in the early hours of 21 July after four days of intense and sometimes fractious negotiations, could have profound implications for the integration of the EU, its bond markets, and also the single currency. It is little surprise that the ‘frugal four’ EU states of Austria, Sweden, the Netherlands and Denmark had argued for a smaller fund and continued to play ‘hard to get’ throughout the negotiations, as a large majority of the €750bn will be issued in grants and may never be paid back.

The potential for an improved economic outlook following the implementation of the fund is likely to have been a factor in the euro gaining in value during the quarter. The single currency was previously held back by the previously slow policy response from the authorities as well as continuing background worries about the potential break-up of the euro if economies continued to diverge. A stronger euro has worried members of the European Central Bank’s governing council, who have warned that an appreciating currency could weigh on exports and drag down prices. Over the summer, the eurozone fell into deflation for the first time in four years.13

In August, the month when Japan had originally been scheduled to host the Olympic Games, the country was rocked by the news that Shinzo Abe, its longest-serving prime minister, was to resign owing to ill health.

Abe leaves behind the legacy of a unique approach in combining both monetary and fiscal policy, which has subsequently spread to other major economies, especially in the wake of the Covid-19 crisis. ‘Abenomics’ was based on the ‘three arrows’ of monetary easing from the Bank of Japan, fiscal stimulus through government spending, and structural reforms. Although Abe ultimately failed in his key goal of sufficiently reviving the economy to achieve a 2% inflation target, it is likely that the country would have found itself in a more difficult position without his stimulative economic policies and the stability that he brought to government.

Abe’s successor as prime minister, Yoshihide Suga, was a key member of Abe’s administration, so is likely to maintain support for monetary stimulus, while further fiscal stimulus is widely anticipated as the Japanese economy struggles to recover from the pandemic.

Shinzo Abe

China’s retail sales saw a 0.5% rise in August compared with the same month a year earlier14 – the first time they have returned to growth since the virus outbreak. However, it is areas such as industrial production (which has grown 5.6% year on year) and property investment which have been driving the country’s recovery. As China’s economy ground to a halt earlier in the year, monetary and fiscal policy shifted in favour of economic stability at the expense of financial stability. Alongside this, credit growth has accelerated and, importantly, restrictions placed on the opaque and less tightly regulated shadow banking sector in 2018 have been lifted, meaning that this expansion of credit will serve to support the economy through the crisis.

Some of this credit is finding its way into the housing market which has for some time been a key driver of the Chinese economy – the fiscal multiplier of property investment ensures that stimulus gets plenty of ‘bang’ for its buck. Some credit is also finding its way into infrastructure. The lockdown, in combination with increased uncertainty around the economic outlook, inevitably led to a collapse in private- sector investment, and policymakers have increased state- directed infrastructure investment in order to support the economy.

Events will take their course, it is no good of being angry at them; he is happiest who wisely turns them to the best account.

Euripides (c. 480 – c. 406 BC), Bellerophon

1 https://www.ft.com/content/b37fc114-57e2-4f5e-b4b4-e373dbcd58cc
2 https://www.ft.com/content/802371ab-d35e-4259-8af8-8b393f11abe6
3 https://www.ft.com/content/713be467-ed19-4663-95ff-66f775af55cc
4 https://www.economist.com/leaders/2020/07/23/governments-must-beware-the-lure-of-free-money
5 Bond market returns sourced from FactSet, 01.10.20
6 Equity market returns sourced from FactSet, 01.10.20 (All sterling total returns, FTSE World Index)
7 Gold bullion returns sourced from FactSet, 01.10.20
8 https://www.ft.com/content/827302da-4257-4bbc-a0fa-9bc98f65d661
9 https://www.federalreserve.gov/newsevents/pressreleases/monetary20200916a.htm
10 https://www.ft.com/content/c8b172e2-8f70-4118-9e81-423e9a4b6839
11 https://www.ft.com/content/22eb8317-88b9-4554-914f-7554194bf079
12 https://www.ft.com/content/fc71adfe-8b8d-4656-bafa-24add419b18f
13 https://www.ft.com/content/c986281c-7154-48ac-939d-50e46d64c0ee
14 https://www.ft.com/content/5f28cd8c-407c-418d-bb45-8d81bd2fdbbc

All data is sourced from FactSet unless otherwise stated. All references to dollars are US dollars unless otherwise stated.

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