At the outset of 2021, financial markets had shaken off the shock from the outbreak of the pandemic in the winter/spring of 2020. Governments in numerous countries had launched comprehensive countermeasures, with swift interest rate cuts, bond purchases, expansionary fiscal policies and direct support to vulnerable companies and consumers. This had helped calm nerves and build confidence, which in turn had lifted financial markets to new all-time highs.
Not until 2021, however, did these countermeasures begin to take full effect. Meanwhile, a lot of demand had been put on hold due to uncertainty and direct restrictions on the supply side, not least travel, restaurant visits and other services with physical customer contact. With the easing of restrictions, households had significant amounts of cash ready to be spent.
We thus entered 2021 with strong potential demand in the world economy.
And we were yet to worry about Russia and Ukraine.
Waiting for tighter policies
Bull markets are said to climb a wall of worry. In 2021, inflation was a recurring concern. From the beginning of the year, it was clear that record-low interest rates and rapidly increasing money supply could breathe life into inflation. In turn, this would have to be met with higher interest rates, an obvious menace to both the stock and bond markets.
Furthermore, the combination of lockdowns in many countries and significant backlogs also led to bottlenecks in a number of supply chains in many industries. This, too, was obviously driving inflation. Headline inflation rose, while underlying inflation remained relatively calm for a long time. Interest rates nevertheless rose in the first few months of the year. Their rise was not enough to arrest the bull market, but clearly enough for fixed-rate bonds to fall and value stocks to outpace growth stocks – after growth stocks had delivered better returns than value stocks since 2006.
For months on end, investors kept looking for signs of imminent tightening. All releases from the US Federal Reserve were scrutinised, as were communiques from the European Central Bank and the Bank of England. A change in phrasing might induce temporary market declines, but nothing much was actually done. And stock markets kept rising.
Towards the end of the year, many central banks nevertheless initiated a cautious process of tightening. In Norway, we got two interest rate increases, each of a quarter of a percentage point, before the year was through. In the US, the Federal Reserve had clearly communicated that they were ready to begin tapering, which they did in November. All in all, however, modest tightening measures were implemented in 2021.
Annual review 2021
Read the complete annual review by Chief Economist & Strategist Finn Øystein Bergh: