While the worst of COVID-19 is behind us, the “unanimous belief” in a rapid and frictionless recovery means that heightened volatility or a major market correction is still a live possibility, according to Aviva Investors.
“The setbacks over the winter have, so far at least, resulted in only fairly modest corrections in quite a narrow range of markets. As a result, some parts of the market may still be effectively “priced for perfection”, when that outcome is rarely what actually happens,” Aviva said in its most recent House View report.
“In recent years periods of market exuberance have often been followed by an extreme, but short-lived spike in volatility stemming from market corrections. The trigger for such corrections has been highly unpredictable, but any emerging evidence of possible overheating in the recovery phase is a possible candidate.”
But it’s excessive inflation that looms as the key risk to the post-COVID recovery, with Aviva warning that policymakers view inflation as “yesterday’s enemy” despite a “rich combination of factors” that could move it unexpectedly higher – including policymakers adopting an “increasingly pro-inflation stance” while fiscal and monetary policy is in “maximum stimulus mode”.
“In addition, the supply-side of economies may have suffered permanent damage from the pandemic, coming on top of mounting evidence of long-term secular demographic trends that could weaken supply capacity. We may not see a return to the inflationary booms of the past. But even a modest reappearance could force grating policy-induced bust,” Aviva said.
Permanent economic loss also looms as a risk factor in the post-COVID world despite the enormous fiscal and monetary stimulus deployed in the heart of the crisis, and “GDP may be permanently lower than it would otherwise have been”.
“Even if resources can be redeployed in other areas, transitions are not frictionless and not painless. If permanent damage is worse than feared, the supply-side hit to economies could have damaging knock-on impacts on long-term growth,” Aviva said.
