#Market Strategy — 13.07.2021

Mid-year Outlook 2021: Is The Reflation Story Over?

Prashant BHAYANI CIO Asia, Grace TAM Chief Investment Adviser, Hong Kong & Dannel LOW Investment Specialist at BNP Paribas Wealth Management


  • 1H21 has largely played out according to our expectations. Our tactical reflation, reopening, and recovery theme materially outperformed the broader market.
  • Given the focus on higher inflation and expectations of tapering, how should we reposition our portfolios as we enter 2H21?

Recap of 1st Half 2021

The first half of 2021 has largely played out as we expected. In the January edition of the Asia Navigator Outlook, we mentioned how vaccination will likely be the key catalyst and shape economic recovery in 2021. Indeed, US led the charge in terms of economic recovery, and now we are seeing similar reopening and reflation effects in Europe and other parts of the world after successful vaccine roll-outs.

Additional stimulus was expected at the start of the year, while central banks continued to remain accommodative to ensure smooth economic recovery. These in turn created a “Goldilocks” scenario (not too hot, not too cold) for global economies, which was very supportive for a bull market as markets recovered to pre-Covid highs and even went beyond. 

We were positive on equities with a bias on value/cyclicals and commodities as we expected a rotation from growth, given the reflationary nature of the recovery. This turned out as expected, and we even took the opportunity in May to selectively profit-take selected sectors which were started to get crowded (e.g. industrials and materials to neutral after sharp rallies). In addition, we remain underweight government bonds which produced negative returns in the first half of 2021, with higher yields as forecasted.

10 themes overall performance

Our 2021 themes at the start of this year comprised of short term tactical themes to longer term  megatrends. As the world races towards an unprecedented vaccination campaign to reach herd immunity, many countries were emerging from lockdowns/restriction and we anticipated a surge in demand.

In fact, our tactical theme #1: Global Reflation performed the best thus far, outdoing the MSCI AC World Index by more than 6%.

Another area that has outperformed benchmark so far is ESG, particularly as the topic starts garnering more attention given the global push for cleaner/greener energy as well as the proposed infrastructure bill by President Biden in the US.

Post reflation outlook: What lies ahead?

Clearly, with vaccinations ramped up across the globe as vaccine manufacturers sort out supply issues, a larger proportion of the world will be fully vaccinated sooner rather than later. However, many emerging markets lag in the rollout. Interestingly, many countries, in particular the US and Europe, are already seeing closer to business as usual as we approach the summer months. This has also been reflected in the strong growth of services PMI in the past few months, which will likely remain robust, as more economies globally ease restrictions. 

vaccine vs new doses

Inflation: where are we heading?

We are likely to see an overshoot in inflation for the rest of the year, as stimulus monies make its way into the economy, alongside pent-up consumption and supply bottlenecks. Current high inflation figures are largely driven by base effects and industry specific supply chain constraints. This trend should continue and peak around year-end in the US and early 2022 in the Eurozone. The risk is that higher prices become embedded, which we monitor via long-term inflation expectations. Thus far, that is not the case relative to previous cycles.

us inflation expectation

As reiterated by the Fed, the spike in inflation is within expectations for the reason given above. A large portion of the inflation spike is likely transitionary, and the focus should instead be on the recovery of the labour market. Nevertheless, we now expect inflation in the US to rise by 3.9% for the year (versus 2.5% previously), before easing to 2.7% for 2022 (2.2% previously).

Tapering to be expected; Interest rates rise in 1Q23

As discussed in the previous June navigator, we expected the Fed to start discussion on tapering. What was unexpected was the slightly hawkish tone from the Fed during the June meeting, where the Fed showed less patience towards the surge of inflation, signalling taper and their expectation of two interest rate hikes by the end of 2023. The dot plot showed 13 of 18 officials favoured at least one rate increase by the end of 2023, versus seven in March.

We continue to expect the tapering decision to be announced in September or even earlier in August during the Jackson Hole retreat, and for it to be executed in January 2022. As for rate hikes, we bring forward our expectations for the first rate hike to 1Q23 from 3Q23.

How should we navigate the rest of the year and beyond?

The short-term tactical theme of reflation has played out almost perfectly for the first half of 2021. For the second half of the year, we focus on four longer term themes,  as we turn our focus to reducing volatility as well as equity risk. Within that we have also upgraded some defensive sectors including healthcare.

Mid Year Themes

1.The future of food: health, productivity and water security

2.Cash in on carbon credits

3.Achieve real returns without 100% equity risk

4.Prepare for the consumption tsunami

Please refer to the 2021 Mid-Year themes brochure for details.

Given the remarkable run by equities since its March 2020 lows, the upside for the asset class is likely more muted than at the start of the year. Naturally, we are still positive on equities relative to government bonds as an asset class, but are increasingly more selective in terms of sectors. Real yields remain deeply negative.

Over the summer months, some rotation of equity exposure out of riskier cyclical sectors into more defensive sectors including healthcare, has historically achieved superior results. Low volatility and quality income dividend strategies are also attractive options for income-oriented investors.

How to achieve income with tight credit spreads? In that regard, we favour hybrid asset exposure for income and real returns, such as contingent convertible (co-co) bonds. Meantime, listed and private real estate funds continue to offer attractive valuations, solid yields and the potential for both capital and rental growth over time. Lower-volatility forms of investment in equities can also be achieved via structured products and alternative UCITS funds.

The mid-year themes also consist of megatrends, with a particular focus on sustainability, both on carbon credit as well as a the future of food, which has garnered massive interest in recent years.

Lastly, expect a large increase in consumption as the covid situation normalises, barring the risk of a global covid-resurgence. Travel and housing-related demand, as well as banks and real estate should profit from strong consumption growth. Interestingly, we may also continue to see growth in E-consumption habits (E-entertainment, e-gaming, 5G-related services), given the offline to online structural shift in consumer behavior, as the world embraces a new normal going forward. 


  • In summary, the global economy has rebounded sharply after the unprecedented economic disruption caused by the Covid-19 pandemic starting last year. Nonetheless, the recovery remains far from over, given the unsynchronized pace of re-opening globally, while virus mutation continues to pose as a risk towards global growth.
  • Inflation bottlenecks are starting to look increasingly heated, which also brought about discussions of tapering as well as rate hikes. As it stands, we see the Fed announcing tapering plans as soon as August during the Jackson Hole retreat, with implementation by either the end of the year or start of 2022.
  • Against this backdrop, our mid-year themes aims to re-position portfolios and diversify and reduce volatility, by seeking returns in other asset classes, and also focusing on longer term megatrends.


Read June Issue of Investment Navigator - Inflation Scare & Tapering Fear: Will History Repeat Itself?


Overview of our CIO Asset Allocation for July 2021

asset allocation july

GDP & CPI Forecasts



  • Our global GDP forecast is more positive compared to global consensus given our expectation of a global strong and sustained recovery.
  • In the US and the EU, stimulus, policy and economic reopening are contributing to our strong growth expectations. In Emerging Markets, we see outputs rising to pre-pandemic levels.


  • Current high inflation figures are largely driven by base effects and industry specific supply chain constraints.
  • This trend should continue and peak around year-end in the US and early 2022 in the Eurozone.
  • Long-term inflation prospects are more unsure, but we foresee a return to pre-Covid levels.


  • Equities not so expensive in an “everything is expensive” world: While global equities’ forward PE of 18.7x looks expensive against a long-term average of just under 15x, government bonds, credit and cash look even worse value. We maintain our positive stance on equities.
  • Upgrade Asia technology to positive:
    • Valuations are more reasonable after correction YTD;
    • Key concerns on regulation are largely priced in;
    • Catalysts in subsectors in 2H e.g. in mobile games, online travel agencies;
    • Investments in new initiatives in e-commerce is already well expected, with stocks likely to show positive momentum;
    • As China macro growth momentum decelerates in 2H, we expect interest in secular growth names to be rekindled. 

Fixed Income

fixed income
fixed income 2
  • The Fed changed the tone slightly at the June FOMC meeting, suggesting less patience when it comes to inflation and signaling earlier-than-expected rate hikes according to the median “dot” of all policymakers’ rate forecasts. This indicates that the Fed may slightly speed up the process of reducing the bond purchases, allowing it to make a first rate hike in 1Q 2023, which would be about 6 months earlier than our previous forecast. 
  • This also suggests that US short-term bond yields could become less anchored by the Fed over the next few quarters and may grind higher with higher volatility. We thus raise our 12-month 2-year yield forecast to 0.6% from 0.4% and 5-year yield to 1.25% from 1%, and turn neutral from positive on US short-dated government bonds. 

Forex & Commodities


Renewed risk aversion linked to fears over renewed lockdown and long-term growth prospects, as well as the sudden fall in long-term US rates relative to short-term rates supported the dollar in recent weeks. We expect the dollar strength to persist over the summer months.

Over the coming year, the euro will be supported by a stronger economic momentum and a risk-on environment. As we revise up the short-term US government bond yield targets amid earlier than previously expected Fed rate hike (possibly 1Q 2023), this suggests less downside for the USD. We revise down our 3–month and 12-month EURUSD targets to 1.17 and 1.22, respectively.

GOLD: Gold remains our preferred hedge against economic, financial and geopolitical risks. We believe central banks will be inclined to keep real rates as low as possible given the high level of public debts.

OIL: Global demand is reaching pre-pandemic levels while supply is still restricted. The medium-term outlook is bullish, while we remain neutral as oil is overbought and vulnerable to any change in political factors (Iran, OPEC+) in the short term.

BASE METALS: We turned neutral from positive at end-May as we expected a lower demand from China in H2. The long term outlook remains bullish.

forex forecast

Strategic & Tactical Asset Allocation


strategic and tactical allocation