The consensus in the financial markets is that 2021 will be far better than this year. With the prospects of effective vaccines, the world is ready to slowly come back to normal in the year ahead.
What are the risks of such a scenario? More importantly, if any of the risks materialise, how will financial markets react?
Planning is important in any business, so traders should spend a lot of time planning for the worse and hoping for the best. In financial terms, this is called risk management.
What Can Go Wrong?
The biggest risk of them all comes from the way the pandemic evolves. The new virus strain discovered in the United Kingdom has quickly spread to fourteen other countries. While vaccination is underway, it takes time until a critical mass of people gets vaccinated – precious time as the new strain spreads much faster than the initial one. The logic tells us that if governments in countries like the United Kingdom, Spain, France, or the United States, had a hard time containing the first variant, they will have a more difficult struggle with this new mutation of the virus.
The good news about vaccines brought much-needed hope. But it also brought relaxation and people letting their guard down.
While we can see the light at the end of the tunnel, the road to it is still long. If the new variant spreads, as studies show, a country with 10% of the population already recovered from the illness and that expects to vaccinate 5% of its population a month would only reach immunity in September next year or so. With the new strain, a higher level of herd immunity is needed (75%-80% when compared to the initial 60%), pushing the date to December 2021- January 2022.
Markets will not remain indifferent to such developments. Now it is the end of the year, and people prefer to focus on something else. But the months ahead are critical in both how the world deals with the pandemic and how governments deal with the economic situation.
So far, during the pandemic, countries lived from borrowing and printing money. The more these habits prolong in time, the more difficult it is to come back to normality.
Science came to help once again. It delivered the much-awaited vaccines, but it cannot solve the economic consequences of a pandemic. For many families, having a job is equally important to avoid the virus. What would millions and millions of households around the world that lost their incomes do once the virus is under control? Could they find a job asap? Doubtful.
2021 may be the year the world wins over the pandemic. It might also be the year when financial markets realise the economic damage.
If that is the case, the USD should bounce strongly. Despite record printing, most debt in the world is denominated in USD – to service it; one needs to buy dollars. Stocks may correct or even enter bearish territory as the USD appreciates.
Risk management skills were never so important as right now.