Markets last week
With the ink barely dry on the US$1.9trn fiscal stimulus in the US, President Biden started focusing on the next spending legislation, potentially as big or even bigger, but this time involving tax rises rather than simply borrowing. The next package is an opportunity not just to fund key initiatives like infrastructure, climate and expanded help for poorer Americans but also to make changes to the tax system. The tax increases are likely to include repealing portions of Trump’s 2017 tax law that benefit corporations and wealthy individuals.
Whereas the last fiscal stimulus was approved by every Democrat in Congress and voted against by every Republican, the Biden Administration is working towards getting some Republicans to vote for the next bill. In that respect, House Republicans voted to allow their members to request dedicated-spending projects for their states, known as earmarks (and by the less charitable moniker ‘pork barrel’), following that same move by Democrats, in a positive sign for Biden’s hopes for a bipartisan infrastructure bill.
The US Treasury has started sending US$1,400 cheques to about 80% of the US population, which adds up to some US$400bn. Some were already received last week and some recipients started spending whereas others chose to invest the proceeds.
The most significant event last week was the meeting and conference by the US Federal Reserve (Fed). Although no changes were made to rates or asset purchases, upgrades were made to growth and inflation forecasts. Fed Chair Jay Powell reiterated his view that inflation spikes would be transient, but bond markets decided to test his mettle right away by pushing yields to 1.75% on the US 10-year government bond and causing a hit on many equity sectors like technology. The bond yield hike was an overt challenge to Powell by so-called ‘bond vigilantes’ but the equity tantrum so far is way too small for the Fed to intervene.
The Bank of England didn’t quite have to face the music the same way and enjoyed a non-eventful meeting and market reaction. UK inflation expectations, however, rose to the highest level since the global financial crisis with the 10-year breakeven inflation rate climbing to 3.48%, the highest reading since 2008, up almost 50 basis points so far this year.
At the end of the week, equities were mixed with Japanese shares doing best and the UK faring worst. Most of the action was within equity markets in sector divergence, with the strongest sector (healthcare) beating the weakest (energy) by 7%. Bond yields rose almost everywhere but in particular in the US. Oil prices collapsed towards the end of the week on concerns about oversupply and the strength of the US dollar.
The week ahead
Wednesday: UK manufacturing and services PMIs
Our thoughts: manufacturing has been behind the strong recovery from the COVID-19 recession globally and hence manufacturing PMIs worldwide have been incredibly strong for a long time. Nothing much is expected to change there this week. The important issue is whether the services activity recovers from its long slump, all the more vital in the UK which is an overwhelmingly services-orientated economy. The market is estimating a rise above the 50 threshold between expansion and contraction for the services PMI. Markets, particularly sterling and gilts, are likely to react to any large deviation from expectations.
Friday: Chinese industrial profits year-on-year
Our thoughts: Chinese total profits in industrial enterprises are an excellent gauge for economic activity in China. They collapsed 40% post-COVID-19 and, although they have recovered to pre-COVID-19 levels, they are still way below the 2017 peak. The trajectory is upwards, though, but how much further can they go, particularly if the government is starting to clamp down on certain sectors and large ’platform’ companies? The largest profits come precisely from these companies, so it will be interesting to see how far the recovery still extends against that backdrop.
Friday: US PCE (personal consumption expenditures) deflator and core PCE deflator
Our thoughts: waiting for inflation changes is likely to be like watching paint dry, but it may be rewarding ultimately once we see the increases and understand where they come from. The core PCE (personal consumption expenditures) is the US Federal Reserve’s gauge for inflation. Whilst the world examines the CPI (consumer price index), the Fed scrutinises the core PCE. Fed Chair Powell has repeated many times that the Fed will be patient with spikes in inflation this year, but, as markets don’t seem to be paying attention, a market tantrum could follow the first big rise in inflation. The core PCE is expected to remain at 1.5% but any deviation from that estimate will have an impact on nervous markets.
Markets for the week
Central banks/fiscal policy
A tale of two central banks – the Fed being the one moving markets
On Wednesday, the US Federal Reserve (Fed) left interest rates and its quantitative easing (asset purchase) programme unchanged.
There were changes in the economic forecasts, however, with core PCE inflation expected to rise to 2.2% this year, up from 1.8% in the December forecast. The forecasts for next year and 2023 have risen to 2.0% and 2.1%, respectively. The unemployment forecasts are revised down this year to 4.5%, to 3.9% in 2022 and 3.5% in 2023. We note that 3.5% matches the unemployment low pre-COVID-19, which was a cycle low. It therefore means that for the Fed to raise interest rates one of its criteria, which is full employment, is now realistically achievable by the end of 2023.
However, the other criterion for rate hikes, which is inflation ’moderately above the target for some time‘, is not likely to be reached during the forecast period. The new projections for inflation and rates are caused by higher growth this year at 6.5% vs. 4.2% in the December forecast. The forecasts for 2022 and 2023 are little changed at 3.3% and 2.2% respectively. This again shows that the Fed views the current rebound as temporary both in growth and inflation.
The language of the statement was little changed from January. Growth is now said to ’…have turned up recently‘ vs. the January statement saying that activity had ’moderated’.
The Fed does not think that inflation spikes will become embedded in 2022 and 2023 due to expectations but also wage growth. Chair Jay Powell repeated his view that rising inflation will be ’transient‘ and hence does not require higher rates. This obviously means a steeper yield curve as the bond market reacts to higher growth and inflation while the Fed doesn’t.
On Thursday, the Bank of England reiterated that it doesn’t intend to tighten monetary policy until there’s clear evidence of a recovery. No change to its target for asset purchases of £895bn. Governor Andrew Bailey said “There is judged to be a material degree of spare capacity at present. The outlook for the economy, and particularly the relative movement in demand and supply during the recovery from the pandemic, remains unusually uncertain.”
Philly Fed survey shows stimulus boost after weather hit on February data
Surveys: the Empire State manufacturing survey rose from 12.1 to 17.4, above consensus. There was a stonking Philadelphia Fed survey, surging to 51.8 from 23.1 against an unchanged estimate and the new orders component rose to 50.9, a 50-year high. This is the first datapoint that shows the impact of the US$1.9trn stimulus, but it won’t be the last. The report showed mounting evidence of bottlenecks and pricing pressure. Also, the US leading economic indicator rose 0.2% in February.
Sales and production: February data reflected weather-related disruptions due to the blizzard in many parts of the US. Retail sales declined -3.0%, and industrial production was down -2.2% in February. It is likely that there will be a strong rebound in March, even before the fiscal stimulus kicks in.
Housing: the NAHB homebuilder index dipped to 82 from 84, below the consensus, 84. The drop should be mostly caused by the February storm but may also reflect falling mortgage applications.
US housing starts plunged -10.3% in February, with building permits declining -10.8%. Single-family permits declined -10.0%. Again, weather-related disruptions may have affected the numbers.
Employment: the US labour market has not yet healed, with weekly jobless claims rising to 770K from 725K. Continuing claims fell to 4.12 million. Claims in all unemployment programmes totalled 18.22 million, so there is still a lot of slack in the economy which should act a as brake on inflation surges.
Borrowing spree begins
Public finances: the UK government borrowed £19.1bn in February, below consensus but the highest February figure since records began.
Surveys: the GfK consumer confidence survey improved somewhat from -23 to -16.
Small improvements in surveys
Surveys: the ZEW expectations index in Germany rose to 76.6 in March, from 71.2 in February and the current situation index rose to -61.0, from -67.2 in February, both above estimates. These data are in line with the Sentix survey the previous week.
Auto sector: new car registrations in the EU 27 fell by 19.3% year-on-year in February, after a 24% decline in January.
Inflation: the CPI (consumer price index) in the eurozone was unchanged at 0.9% year-on-year in February, matching the initial estimate and consensus, while the core CPI (excluding energy, food, alcohol and tobacco) was also unchanged at 1.1%.
One-year anniversary of COVID-19 for China shows strong numbers
China: the monthly data for February looked very strong but beware of the Chinese New Year timing and the comparison with last year at the height of COVID-19.
Industrial production up 35.1% year-on-year, fixed assets ex rural (i.e. investment) up 35%, property investment up 38.3% and retail sales up 33.8%. The surveyed jobless rate rose to 5.5% vs. 5.2% estimated. The 1-year medium term lending facility rate remained at 2.95%.
Japan: industrial production rose 4.3% in January and capacity utilisation increased 4.7%. The tertiary industry index (i.e. services) fell 1.7%, though.
Oil fell 7% on Thursday, in part due to the stronger dollar and a gain in US stockpiles. For the week as a whole, Brent crude fell 6.8%, copper was flat and gold rebounded from the US$1,700 level.