Make Kitco Your Homepage

Central bank domination over financial markets to continue through 2021

Kitco News

Kitco News has launched its 2021 Outlook, which offers the most comprehensive coverage of precious metals markets in the new year. Trillions of dollars were pumped into financial markets in 2020 and that won't come without consequences. Economists expect that investors will be Bracing For Inflation in 2021.

(Kitco News) - In the last few weeks, investors have heard many analogies to describe financial markets in 2020. The best one is probably from Wells Fargo, whose economists said that this past year financial markets got drunk on central bank liquidity and 2021 is not the year they are expected to sober up.

Since March, central banks and governments around the world unleashed a tsunami of liquidity into financial markets to prop up the global economy devastated by the COVID-19 pandemic. According to the International Monetary Fund, nations and central banks around the world have committed more than $19.5 trillion to fight the impact of the coronavirus pandemic.

In the U.S., stimulus measures in response to the COVID-19 pandemic totaled 12% of GDP, three times bigger than the response to the 2008 financial crisis. The Federal Reserve's balance sheet continues to hit new records levels above $7 trillion.

Now the question is, just how do investors navigate these turbulent investment waters in 2021?

Central banks have launched unprecedented monetary policy stimulus measures in 2020. Economists and analysts expect that this work will continue through 2021. Although the global economy is expected to see more than 5% growth in 2021, economists said that the scars of the 2020 pandemic will continue to be felt through the new year.

The Federal Reserve itself said that it is committed to doing whatever it takes to support the U.S. economy as it continues to feel the effects of the COVID-19 pandemic.

"We do have the flexibility to provide more accommodation," said Federal Reserve Chair Jerome Powell after the central bank's last monetary policy meeting of 2020. "Purchases will continue until the job is well and truly done."

According to its latest projections, the central bank is expected to keep interest rates at the zero bound range through 2023.

But the Federal Reserve is not the only central bank that is maintaining ultra-loose monetary policies. In its last monetary policy meeting of 2020, the European Central Bank increased its pandemic emergency purchase program (PEPP) by €500 billion to a total of €1,850 billion. It also extended the horizon for net purchases under the PEPP to at least the end of March 2022.

ECB President Christine Lagarde has also said that the committee stands ready to adjust all of its instruments, as appropriate, as they see uneven growth in the European Economy through 2021.

With interest rates already at rock bottom, some analysts think that the central banks' toolboxes are looking a little bit empty. However, many analysts expect that the major policy announcement to watch for in 2021 will be yield curve control, especially if nominal bond yields start to pick up as the global economy picks up, particularly in the second half of the year.

"If we start to see bond yields push back above 1%, then you will see central banks step into the market," said Chantelle Schieven, head of research at Murenbeeld & Associates. "Central banks can't afford to let interest rates go much higher because it would cost the government too much to service its debt."

With interest rates expected to remain low and inflation expectations pick up, many analysts continue to see the potential for precious metals with expectations that gold prices will retest their all-time highs above $2,000 an ounce.

However, gold and silver won't be without competition. In a low-interest-rate environment, improving economic activity in the second half of the year and risk back-stopped by central bank action, many analysts see further gains for a red hot equity market.

"We underweight government bonds and see equities supported by falling real rates," said analysts at BlackRock, the world's biggest asset management firm, in their 2021 outlook forecast. "Our low rate outlook keeps us pro-risk. We like U.S. equities and prefer high yield for income."

Analysts at CIBC also look for equities to continue to perform well in 2021; however, they also see a role for gold in a balanced portfolio.

"We still believe that the de facto trade for next year is to rotate out of income-generating assets and into capital-appreciating assets. We focus on a rotation out of Treasuries and into equities, though this is certainly not the only variant," the analysts said in their 2021 outlook report. "For example, if you believe you can get strong capital appreciation off gold, you should rotate into gold, which is bucketed in the same capital-generation bucket as a risk."

While equity markets will continue to benefit from ultra-loose monetary policy, some market analysts have said that the need for gold as an uncorrelated asset will become essential in a portfolio in 2021.

"The Fed put will be alive and well in 2021," said Peter Grosskopf in a recent interview with Kitco News. "Yields are being artificially repressed and it that is building the 'everything bubble.'"

Grosskopf added that with low to negative real bond yields, gold is really one of the only insurance policies investors have to protect their portfolio and balance against over-extended equity markets.

"The question for investors, though, is just how much insurance are they going to need in 2021," he said.

Analysts at Crossborder Capital are also warning investors to use caution when it comes to jumping into the equity markets that are being driven by central bank liquidity.

"The best time to invest in equities is when an aggressive Central Bank is trying to stimulate a sluggish economy,' the analysts said in a report published at the start of the month.

However, they also added, "The more upbeat we become about world economic prospects in 2021, the more vulnerable are global stock markets. If we are forced to time the up-coming cycle swings, we should think about rotation into potential 'catch-up' stories for Q1 2021, such as gold."

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.