Markets last week

A complicated week for markets, due to many different economic factors offering conflicting paths for the future. The JPMorgan Global Services PMI had the third successive increase in April, to 56.6 and points to higher bond yields. It was stuck round the 52 area for 6 months and has now taken off, showing that the baton of economic growth has been passed from manufacturing to services in most parts of the world.

On the manufacturing side, widely-used, just-in-time inventory management has created bottlenecks. The prices of aluminium, copper, chemicals, steel, plastics, cotton, shipping, wood and lumber products all have been driven up by product scarcity, not to mention semiconductors, even cheese! These higher costs are feeding into inflation levels and worrying markets. For most companies, however, labour costs are much more significant than other costs and there is no sign yet of surging wages and salaries, a comment that was repeated by various Fed members in the last few days.

A shocking disappointment on US payrolls on Friday helped growth equity sectors vs. value sectors, especially the favourite lockdown shares and pushed government bond yields down abruptly, but ultimately investors realised that numbers can be erratic and require confirmation before being taken as a trend. It is becoming increasingly evident that job creation is being stifled by bottlenecks and skills mismatches.

Risk appetite is still strong, as evidenced by tight credit spreads, copper outshining gold, strong consumer discretionary shares and cyclical sectors beating defensives, strong bank stock performance, Brent oil approaching US$70/bbl. Also, information technology has registered the first 52-week relative low since 2012. Chinese internet stocks have not bounced back and the Initial Public Offerings (flotations) are also negative in relative terms. Equity market leadership is still favouring cyclical value.

Gilt and treasury yields, however, seem to be stuck, waiting for the next spurt of outsize growth, structural inflation or massive employment surges before going on the next leg up, which is why we see equities rising and bond yields flat to lower.

At the end of the week, equities were higher, with some indices hitting highs. UK equities did best and emerging markets lagged. Bond yields fell and commodities surged, particularly copper. The US dollar was weak against most currencies.

The week ahead

Monday-Tuesday: Chinese CPI (consumer price index) and PPI (producer price index)

Our thoughts: once again, inflation is the leading market issue and sources of inflation are under scrutiny. China, as the premier manufacturing location, is feeding its costs into the rest of the world. The expectation for PPI (producer price index) is for an increase from 4.4% to 6.5% year-on-year. It’s easy to forget that, not long ago, Chinese PPI was still negative and China had been exporting deflation to the world for a couple of decades. Producer prices will definitely impact inputs in Western economies and should be reflected in data like import costs in the US. China’s CPI (consumer price index) may matter less globally but its path will help understand where other countries could end up. The estimate is for 1% CPI, up from 0.4% the previous month.

Tuesday: UK data for March (manufacturing production, construction output, index of services)

Our thoughts: we have gone from the UK being the most depressed economy in the West last year to potentially the fastest-growing during 2021. The Bank of England has upgraded its growth forecast to a whopping 7.25% this year, so the question is how such a number can be produced. Understanding which economic sectors can deliver will be crucial. The data for March include manufacturing production, construction output and the index of services. Based on the recent manufacturing, services and construction PMIs all above 60, there is no reason why all sectors should not pull their weight, but the devil may be in the details and any outliers could move markets.

Wednesday: US CPI (consumer price index)

Our thoughts: the US CPI is not the Fed’s gauge (rather, it is the core PCE – Personal Consumption Expenditures) and the difference between both indices is significant, in particular due to the percentage of housing rentals in the calculation. Nevertheless, CPI will be the market mover, much more than core PCE. Current estimates for headline CPI are lifting the reading from 2.6% to 3.6%, with the core PCI (ex food and energy) rising from 1.6% to 2.3%. Against a backdrop of disappointing jobs data, inflation should not overshoot expectations, lest we start talking about “stagflation”. Either way, the number is likely to move the markets.

The numbers for the week 

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

US Fed members and Bank of England coincide on inflation views

On Tuesday, US Treasury Secretary Yellen stirred markets by saying she didn’t anticipate a bout of persistently higher inflation, but that if one occurred the central bank has the tools to deal with it: “it may be that interest rates will have to rise somewhat to make sure our economy doesn’t overheat. It could cause some very modest increases in interest rates”.

Eric Rosengren, Boston Fed President, delivered a speech with detailed economic slides, focusing on inflation. He said that inflation forecasts in the private sector show a median of 2.3% for 2021 and 2.0% for 2022. He saw the most likely outcome as a temporary inflation acceleration. Fed members Loretta Mester and Richard Clarida also joined the Fed chorus saying that inflation spikes are temporary.

US Federal Reserve Chair Jerome Powell called the risks emanating from “frothy” stock prices and other potential financial imbalances “manageable”. “You are seeing things in the capital markets that are a bit frothy. Some of the asset prices are high.” He argued that a growing number of vaccinations and a faster economic reopening were the main forces driving prices higher, not Fed policy. Powell also pointed out that some of the other factors the Fed looks at to assess financial stability risks are not flashing red. Household balance sheets are in good shape, leverage in the financial system is not high and banks are well-capitalised. Fed Governor Lael Brainard echoed his views: “Vulnerabilities associated with elevated risk appetite are rising. The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a re-pricing event”.

The Bank of England’s MPC (Monetary Policy Committee) kept the Bank Rate unchanged at 0.10% and kept its target government bond purchases at £875bn. The Committee decided to slow its weekly purchases of government bonds to £3.4bn, from £4.4bn. The most interesting part of their statement was a revised forecast for GDP growth in 2021 to 7.25% from 5.0%, but down to 5.75% from 7.25% in 2022. Net-net, the projected level of GDP in 2023 is 1% higher than in February. The MPC continues to think that the forthcoming period of above-target inflation will be short-lived, expecting inflation to peak at 2.47% in Q4 2021, before falling to 1.96% in Q2 2023 and 1.91% in Q2 2024.

United States

Shockingly poor payrolls contrast with strong data throughout week

Industry: factory orders and durable goods were strong as expected, with factory orders up 1.3% in March, durable goods orders up 0.8% and 1.9% ex transportation.

Surveys: the ISM services index dipped to 62.7 from 63.7, below estimates, but the index level is still the second highest on record. The Markit services PMI rose, though, from 63.1 to 64.7.

Employment: initial jobless claims fell to 498K from 590K. Non-farm payrolls disappointed at 266K instead of the one million expected, with the previous month revised down 146K. Leisure and hospitality jobs were up 331,000, but manufacturing jobs were down 18K, trade and transportation, healthcare were all below expectations. Many unusual factors may have affected the data. There is undoubtedly a potential labour supply issue; we have not hit the point yet where benefits end and people are forced to take jobs. The silver lining was the labour force participation rate up from 61.5% to 61.7% and underemployment (U6) down from 10.7% to 10.4% whereas unemployment (U3) rose from 6.0% to 6.1%. Average hourly earnings were up 0.7% in April vs. -0.1% previous month.

Productivity: Q1 productivity rose at a 5.4% rate with unit labour costs falling at a 0.3% rate. This is a very positive reversal from the previous quarter, but we have to be cautious in interpreting the data, due to COVID-19 noise and discrepancies.

United Kingdom

Amazingly, manufacturing, services and construction are all pitching in

Surveys: the Markit/CIPS manufacturing PMI rose to 60.9 from 58.9, showing that current manufacturing output is close to the January 2020 level. The Markit/CIPS services PMI increased to 61.0 in April from 56.3 in March, a high since October 2013. The services output price index at 55.1 in April remained in the top 5% of all readings since 1996.

The Markit/CIPS construction PMI edged down to 61.6 in April from 61.7 in March, with the activity indices for commercial, civil engineering and new housing work all above 60. Growth in order books was the highest since September 2014 and employment the highest since December 2015.

Credit: the number of house purchase mortgage approvals fell to 82.7K in March from 87.4K but UK mortgage borrowing moved to a record £11.8bn, the highest since records began in 1993.

Income and savings: Bank of England data showed that UK households continued adding significant amounts to their bank accounts, with another £16.2 bn deposited in March.

Money Supply: M4 money supply fell from 13.7% year-on-year to 10.8% in March.

Auto sales: UK private new car registrations totalled 141.6K in April, much higher than the 0.9K in April 2020, but year-to-date registrations are 17% below their 2010-to-2019 average and still well short of pre-COVID-19 levels.

Europe

Still driven by manufacturing over services

Surveys: the eurozone services PMI edged up from 50.3 to 50.5.

Industry: German factory orders jumped 3.0% in March, with the year-on-year rate up to 27.8% from 5.6%. Industrial production in Germany rose by 2.5% in March with the year-on-year increasing to 5.1%. Industrial production in France increased only by 0.8%, with the year-on-year up to 13.7%.

Sales: retail sales in the eurozone rose by 2.7% month-to-month in March, with the year-on-year rate up to 12.0% from -1.5% in February. A large gain in Germany, up 7.7%, was the main driver of the upside surprise.

China/India/Japan/Asia

Has China managed the transition from industry to consumer?

China: the Caixin Services PMI soared from 54.3 to 56.3. The trade balance in US dollars rose from US$13.8bn to US$42.8bn, with exports rising 32.3% year-on-year and imports rising 43.1%. Foreign exchange reserves rose further from US$3.17trn to US$3.2trn.

Japan: the Jibun Bank Japan Services PMI rose from 48.3% to 49.5%. Labour cash earnings rose 0.2% in March vs. -0.4% the previous month and real cash earnings rose to 0.5% from 0.1%.

Oil/Commodities/Emerging Markets

Oil prices rose again with Brent nearing US$70/bbl, copper stayed above US$10,000/metric tonne and gold recovered the US$1,800 level per oz.