Key Forecast Trends

• Although the near-term outlook remains challenging—especially in Europe, where output looks set to contract again in the first quarter—markets are still laser-focused on prospects for recovery once economic restrictions have been lifted.
• With governments and central banks still providing abundant liquidity and support, the only development likely to challenge this narrative would be the emergence of a more deadly or vaccine-resistant virus mutation.
• Reflationary hopes have been boosted by recent developments in the US. With the Democrats now in effective control of both houses of Congress, the route towards additional fiscal stimulus has cleared.
• The outlook for bond yields has become less certain. In Europe and Japan, where monetary and fiscal policy are acting in concert and central banks are committed to implicit or explicit yield-curve control, the risk of higher yields is low.
• By contrast, the Federal Reserve (Fed) is not committed to yield-curve control and might see additional fiscal stimulus as a reason to begin winding down its own support for the economy. Speculation about Fed tapering should remain low while COVID-19 continues to dominate the headlines but could become an important driver later in the year.
• But even if risks are now skewed towards higher US yields, the Fed is unlikely to tolerate an abrupt increase. A return to the pre-pandemic trading range remains a distant prospect, in our view.