Markets last week

A market tantrum derailed both bonds and equities last week. The Chair of the US Federal Reserve Jay Powell reiterated the Fed’s policy on rates and inflation, but that did not stop US Treasury and other government bond markets from selling off sharply. Earlier in the week, investors had started shifting out of pandemic winners and reinvesting in ’reopening’ plays, in particular in the UK following the PM’s plan to restart the economy from 21 June. With bond yields rising, though, the sector rotation became relentless and hit tech shares above other sectors. On Thursday, the whole of the US stock market fell in sympathy, with growth stocks hit by higher long-term rates. This was followed by large drops on Friday in Asian equities.

Energy and financials have been leading the markets, seen as obvious beneficiaries of the rise in bond yields and oil prices. Indeed, the US 10-year yield has risen more than 55 bps this year and, adjusted for inflation, hit its highest level in more than seven months. These higher borrowing costs are expected to hurt businesses that have benefited from exceptionally loose financial conditions. The UK 10-year gilt yield topped 0.8% on Friday.

Risk appetite did not vanish, though. Oil prices kept soaring; copper prices continued their winning streak, a symbol of the global economic recovery. Fed Chair Powell said that higher bond yields meant growth was picking up, which pleased him.

During the week, UK stocks did best, with the main underlying sectors being the flavour of the day (energy, materials, financials). Europe was also resilient, sharing some similarities with the UK market, but technology in the US and China were the biggest losers. It was also noteworthy to see the negative turn taken by the Japanese market. On Friday, US tech bounced back against a broadly negative backdrop.

After surging to over US$1.41 and €1.16, sterling settled back down to US$1.39 and €1.15.

On the virus front, the announcement came that two doses of the Pfizer vaccine on 600,000 people in Israel prevented 94% of infections compared to another 600,000 who did not get the jab, which is an excellent efficacy level and should continue to support risk appetite, as investors see the end of the lockdowns and fiscal stimulus helping risk assets during this period.

The US House of Representatives passed President Biden’s US$1.9trn stimulus bill, but the Senate may be more difficult to convince, in particular about the US$15/hour minimum wage.

The week ahead

Monday: US ISM Manufacturing PMI

Our thoughts: the ISM (Institute for Supply Management) always provides very detailed analysis of manufacturing activity in 18 different sub-industries in the US. The last few surveys were unusually strong and seemed to predict the extreme run-up of bond yields of the last month, with a massive economic recovery now being priced in. The ISM survey also looks at new orders, inventories, prices paid and employment. Other than employment, these categories were all very bullish at the last reading. If jobs are improving, as witnessed by the lower jobless claims last week, then how are all the sub-categories going to fare in light of the strongest economic upswing in decades?

Wednesday: UK Markit/CIPS Services PMI

Our thoughts: the recovery in the services PMI floundered amid the various lockdowns imposed in the different nations of the UK. The latest services PMI is still below the 50 threshold between contraction and expansion and it’s fair to say that services activity in the UK has been depressed. How much of an improvement is there with the vaccine drive in full swing and with the Covid curve finally improving? The UK economy has been carried by manufacturing and construction, as services were often paralysed by lockdowns. How soon can we see a rebalancing of these sectors?

Friday: US employment data

Our thoughts: the non-farm payrolls data often move money markets, as they offer the best picture of the US economic activity on a real-time basis. This time, the recent improvement in jobless claims is leading forecasters to assume a much higher level of job creation. Is it too early to see this and will markets be disappointed? Will the new payrolls come from the private sector only, after the census work ended? Will they be in services or manufacturing? Will there still be job losses in travel and hospitality? Will those job losses keep raising average weekly earnings, as low-paying jobs continue to be culled? Also, how much underemployment is there and what is the labour participation rate? The answer to these questions could have an impact on the market’s perception of impending inflation rises.

The numbers for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

The Fed reaffirms policy on inflation but are markets listening?

Treasury Secretary Janet Yellen said that President Biden favours raising corporate tax and would be open to higher capital gains tax rates, which may be an offset later in the year if there is a further infrastructure spending plan that has to be more revenue-neutral to pass through Congress.

US Federal Reserve (Fed) Chair Jerome Powell testified in front of the Senate and confirmed that the Fed was nowhere close to pulling back on its bond-buying support, even as he voiced expectations for a return to more normal activity later this year. Some analysts are saying that his comments on growth and employment mean that tapering of purchases is coming before year-end. Indeed, Powell said that growth this year likely gets to 6% maybe even 7%, an increase from 4% forecast earlier. He also played down concerns over inflation from another big COVID-19 bailout or the unleashing of pent-up demand as vaccinated Americans who didn’t lose their jobs start spending. “The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved.” During a second day of Congressional testimony, he insisted the labour market is still in trouble and signs of rising prices won’t necessarily lead to persistently high inflation.

One additional clue to future Fed policy was the speech from Governor Lael Brainard about her views on the employment side of the Fed’s mandate, and what “full employment” means. “The new framework calls for monetary policy to seek to eliminate shortfalls of employment from its maximum level, in contrast to the previous approach that called for policy to minimise deviations when employment is too high as well as too low.” This means that employment can be allowed to run at the maximum possible level.

United States

A better employment backdrop with strong income growth. Will higher mortgage rates kill the housing golden goose?

Surveys: the Conference Board consumer confidence survey improved, but under the bonnet, the details were less bullish. The headline rose from 88.9 to 91.3, but it all came from the present situation rising from 85.5 to 92.0, whereas expectations slipped from 91.2 to 90.8. The reading is still way below pre-COVID-19 levels of 130+. The Richmond Fed manufacturing index was unchanged at 14. The Kansas City Fed manufacturing activity index rose from 17 to 24. The MNI Chicago PMI fell from 63.8 to 59.5. The University of Michigan bellwether sentiment index was barely changed at 76.8 vs. 76.2 with current conditions stable and expectations slightly higher at 70.7 vs. 69.8. Again, this gauge was above 100 pre-COVID-19.

Housing: the housing market is still buoyant. The Case-Shiller city house price index soared into double-digit returns in December with a 10.37% annual return for 2020 and 10.10% for the narrower 20—city index. Separately, the FHFA house price index rose 1.1% in December and the FHFA quarterly house price purchase index was up 3.8% in Q4. New home sales in the US rose 4.3%, still very strong. Pending home sales fell 2.8% in January, breaking the strong run, with the year-on-year numbers up 8.2%, vs. 23.1% the previous month. Mortgage rates in the US rose to the highest level in six months with the average for a 30-year, fixed loan at 2.97%, up from the record low of 2.65% in early January.

Employment: initial jobless claims decreased by 111,000 to 730,000, the lowest in 3 months, with the previous week’s number revised down. Continuing claims also declined by 101,000 to 4.42 million, indicating that pandemic job cuts may be starting to slow.

Industry: US durable goods orders were very strong, rising 3.4% in January with the core reading, durables ex transportation, up 1.4%.

Income and Spending: personal income jumped 10% in January, whilst personal spending only rose 2.4%, broadly in line with estimates.

Inflation: the PCE (Personal Consumption Expenditures) deflator rose to 1.5% in January from 1.3%. Likewise, the core PCE (which is the Fed’s inflation target measurement) rose from 1.4% to 1.5%. Changes in inflation cannot really be expected until at least the March numbers which will come out in April.

United Kingdom

Small changes in jobs and sales

Employment: the claimant count rate was 7.2% for January vs. 7.3% the previous month and the jobless claims change was a negative 20K for the second month, so at least the jobs market is not getting worse. The rising ILO unemployment rate published is December’s and is therefore less meaningful.

Sales: the CBI reported sales were slightly better but still very depressed at -45 up from -50.

Europe

Inflation is still unchanged, despite fears

Surveys: the IFO survey in Germany was very strong, with the expectations component rising from 91.5 to 94.2 and the current assessment at 90.6 vs. 89.2 previously. The German GfK consumer confidence survey was slightly better at -12.9 vs. -15.5. Business confidence, manufacturing confidence and production outlook in France disappointed. In the eurozone, economic confidence rose from 91.5 to 93.4, consumer confidence remained stuck at -14.8, industrial confidence rose from -6.1 to -3.3 and services confidence edged up from -17.7 to -17.1.

Inflation and spending: the eurozone CPI (consumer price index) was unchanged and exactly as expected at 0.2% in January or 0.9% year-on-year with the core CPI at 1.4%. Changes in inflation cannot really be expected until at least the March numbers which will come out in April. French consumer spending fell 4.6% in January, albeit after a 22% rise the previous month.

China/India/Japan/Asia

China: no meaningful statistics last week.

Japan: the Leading Index and Coincident Index were slightly better in January, rising from 94.9 to 95.3 and from 87.8 and 88.3, respectively.

Oil/Commodities/Emerging Markets

Copper and oil still on a tear

While gold fell below US$1,800, it’s surprising how well silver has held up. We’ve had a complete reversal in gold flows from late last summer, which should be supportive. Copper and aluminium have both spiked to their high since 2011. Brent crude at US$66/bbl is already above most price forecasts for the end of this year!