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    Weekly multi-asset update: July

    Weekly multi-asset update: July

    16 July 2021 Multi-asset
    Week to 16 July, 2021

    Summary

    • Federal Reserve acknowledges US inflation prints are higher than expected, but still sees pressures as transitory
    • Earnings season kicks off, with S&P 500 earnings per share expected to grow at +60% growth yoy
    • China growth data surprises to the upside
    • European Central Bank remains cautious on the economic recovery with a surge in cases of the Delta variant
    • Outlook: earnings season continues; the latest ECB monetary policy decision and provisional PMIs for July

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    Weekly review

    Federal Reserve acknowledges US inflation prints are higher than expected, but still sees pressures as transitory

    Federal Reserve (Fed) Chair Jerome Powell provided reassuring remarks this week. He stated the Federal Open Market Committee still sees the US economy as far from making substantial enough progress to consider cutting down asset purchases. However, he also made clear it will discuss tapering in the next Fed meeting on 28 July. Lastly, and rather importantly, on monetary policy the Fed will give the market ample warning before adjusting asset purchases. This should help to avoid a repeat of the taper tantrum in 2013.

    On inflation, Powell noted that data has been higher than expected and hoped for, but still deems the pressures as transitory. This comment followed the second bumper CPI print in a row, with the year-on-year rate rising to 5.4%. Treasury yields jumped on this release but fell back after the above comments from Powell. Digging deeper into this, the bulk of price rises have been in areas where price trends tend to be flexible in their nature. The Atlanta Fed’s ‘sticky price’ index which includes CPI items where prices changes are infrequent (typically less than once every 4.3 months), is a good way of keeping an eye on this. This series, which includes around 70% of the CPI basket, has shown a small up-tick in recent months but is not yet a cause for concern. The analysis suggests flexible prices respond powerfully to economic conditions; sticky prices contain a component of inflation expectations making this a useful guide as to whether inflationary expectations are becoming entrenched. Judging how indicators, such as these, change will be key to assessing inflation risk.

    Earnings season kicks off, with S&P 500 earnings growth set for post financial crisis record

    US earnings season came in to focus this week with the major banks reporting their results for Q2. At the headline level, S&P 500 earnings per share (EPS) is expected to grow at +60% year-on-year, a post financial crisis record. However, this is clearly being distorted by some significant base effects, and it is worth noting that analyst estimates point to a small decline in earnings from Q1 levels. A notable theme in recent earnings seasons has been the large beat on expectations, with Q1 coming ahead of pre-season estimates by +20%. That said, price reaction to positive surprises has been lower than historical averages, and this is something we will be monitoring very closely. Other areas of focus include management commentary on supply constraints and Chinese demand. The key takeaways from the banks reporting this week were that loan growth remains stagnant as both consumers and corporates are flush with cash. This, in combination with lower interest rates, resulted in JP Morgan reducing guidance for net interest income for the rest of the year. The capital markets divisions generally beat expectations, with a fall in trading revenue offset by very strong investment banking revenues.

    China growth data surprises to the upside

    China is the lead locomotive along the COVID recovery track. Data suggests that China's economy peaked in Q4 2020 and activity is now moderating on a sequential basis. That said, data for June surprised to the upside. Retail sales came in at 12.1% (year-on-year) and industrial production at 8.3% (year-on-year), both exceeded market estimates. These strong data prints somewhat alleviate concern amongst investors that a slowdown in growth is taking place. The Q2 GDP reading was also released which showed year-on-year growth stood at 7.9%, slightly below market expectations.

    European Central Bank remains cautious on the economic recovery with a surge in cases of the Delta variant

    European Central Bank (ECB) President Christine Lagarde sounded a cautious tone this week, in light of the surge in cases of the Delta COVID-19 variant and its potential dampening effect on economic recovery. She hinted that the central bank’s current loose monetary policy would be extended well into the future, emphasising the need to be flexible and not give the impression that “the exit” (from current policy) is in the next few weeks or months. Eurozone bond yields fell over the week.

    Outlook: earnings season continues, the latest ECB monetary policy decision and provisional PMIs for July

    Next week could be eventful with attention remaining on the earnings season, where commentary on pricing pressures and guidance in respect to economies increasingly opening will be of interest. Outside of that, the European Central Bank meet on Wednesday for its latest policy decision, however comments this week from President Lagarde suggest monetary policy will remain loose. That being the case, focus will still be on the language used, especially in relation to interest rates, bond purchases and the new average inflation targeting that was unveiled earlier in the month. Lastly, towards the end of the week provisional PMI releases will provide insight into how economic momentum has progressed into July. This is of particular importance to us as we weigh up whether the economy is shifting from an accelerating regime to a moderating regime and what that might mean for expected asset class returns, volatility and drawdowns.

    Week to 9 July, 2021

    Summary

    • Risk assets volatile as the highly infectious delta variant continues to spread across the world
    • The ECB moves to a ‘symmetric’ 2% inflation target, and the EU increases its economic growth outlook
    • Outlook: US inflation and China GDP data releases, and the start of the US earnings season

    Responsible investment in multi-asset

    Please read our white paper on our responsible approach to multi-asset investment.


    Weekly review

    Risk assets volatile as the highly infectious delta variant continues to spread across the world

    Risk assets were more volatile this week as fears crept in that the global vaccination programme is struggling to get economies back to pre-Covid levels of activity. Global cases ticked up again as the highly infectious delta variant continued to spread across the world, which ultimately started to weigh on risk sentiment. Despite the S&P 500 reaching an all-time high earlier in the week, what followed was a notable decline among both cyclical and Covid-sensitive stocks. Bonds followed the risk-off play book, with the yield on 10-year Treasuries falling to their lowest level since mid-February of this year. From here, we think there are two factors that are likely to weigh on asset class behaviour. Firstly, how much longer global economic activity can prolong its current acceleration phase, and what the trajectory of the recovery will be beyond the point of ‘peak growth’. And secondly, how the inflation story will unfold, and whether that will force a material change in expectations in the path of monetary policy normalisation. The challenge facing us is that the fundamental economic backdrop still appears conducive for risk assets, but recent asset price performance already looks good by historical comparison, and those stretched valuations were tested this week.

    The ECB moves to a ‘symmetric’ 2% inflation target, and the EU increases its economic growth outlook

    The European Central Bank (ECB) announced it will adopt a ‘symmetric’ 2% inflation target over the medium term, replacing its previous target of ‘below, but close to, 2%’. The use of language implies a more tolerable outlook on above-target inflation, with the bank highlighting that if rates drop close to the lower bound, then forceful policy will be put into action to avoid any negative deviations from the inflation target becoming entrenched. The ECB also noted that a transitory period is to be expected where inflation is somewhat above target for a period of time.

    In addition, the bank will start to include initial estimates of the cost of owner-occupied housing in its wider set of supplementary inflation indicators. As well as housing, the ECB took note of the significant implications of climate change on price stability, with a commitment to more extensively integrating climate change factors into the framework; however what is yet to be seen is how this will impact the ECB’s stance on green bonds and what this means for market neutrality in the face of further emphasis on climate change action. With a growing demand for ESG focussed bonds across the market, this will continue to be a hot topic as we move into the second half of the year.

    Staying with Europe, the EU increased its outlook for growth in the eurozone economy from 4.3% to 4.8% this year, and from 4.4% to 4.5% for 2022. The revision reflected the better-than-expected recovery in business and social activity in Europe during the second quarter. Regarding inflation, the EU expects it to increase by 1.9% year on year in 2021, before slowing to 1.4% in 2022. Other economic data released during the week pointed to recovery, not least the final composite purchasing managers’ index figure for June, which rose to 59.5, ahead of the preliminary figure of 59.2, and above May’s 57.1.

    Outlook: US inflation and China GDP data releases, and the start of the US earnings season

    There are a number of key data releases next week, including the US CPI reading for June. Recent prints have strongly exceeded expectations, resulting in the Federal Reserve pulling back somewhat on their very accommodative monetary policy stance. Focus will be on this release and the read across it may have to various asset classes. Other data of note is the Q2 GDP print from China, which should set the tone for China’s policy stance for the rest of this year. Also, the US earnings season kicks off next week with several key financial companies reporting.

    Week to 2 July, 2021

    Summary

    • The UK is an interesting test case: rising delta variant cases, high vaccination rates and easing of lockdown restrictions
    • Equity markets grind upwards to set new highs as economic activity nears ‘peak’ growth rates
    • US non-farm payrolls ahead of market forecasts; average hourly wages rising in-line with expectations
    • Inflation key market theme despite below forecast European inflation print; market volatility continues to decline
    • Outlook: US FOMC minutes may provide more colour on central bank outlook; PMI and virus cases other key data points

    Responsible investment in multi-asset

    Please read our white paper on our responsible approach to multi-asset investment.


    Weekly review

    The UK is an interesting test case: rising delta variant cases, high vaccination rates and easing of lockdown restrictions

    Vaccination progress and the spread of the delta variant continues to play a prominent position in the outlook for markets, with the US and many European countries recognising the spread of the more highly transmissible delta variant. In that regard, the UK is an interesting test case. Daily cases in the UK rose by 27k, the highest level since January 2020 and an increase of 72% over the last week. However, the UK has also been a leader in vaccinations, with over 80% of the adult population having received at least one dose and over 60% having received two doses. With the new cases being skewed towards the younger, unvaccinated part of the population, this has placed less strain on healthcare services and lost productivity. The UK remains on course to further ease lockdown measures on 19 July but will be watched closely as a template for other nations at an earlier stage of both vaccinations and the prevalence of the delta variant.

    Equity markets grind upwards to set new highs as economic activity nears ‘peak’ growth rates

    The continued growth backdrop and lack of sufficiently significant data points this week allowed risk markets to grind higher. The European Manufacturing PMIs (Purchasing Managers’ Indices) supported the ongoing recovery story, with the June release being revised upwards to an all-time high of 63.4. In the US, the ISM manufacturing data was more mixed, although the headline number came in firmly in expansionary territory at 60.6, the employment component fell to 49.9. This is below the important 50 level (divide between expansion and contraction) but more likely reflects labour shortages rather than real economic weakness.

    While a pro-cyclical asset allocation bias therefore remains appropriate for now, we remain cognisant that valuations are at relatively expensive levels and the underlying economic regime is nearing ‘peak’ growth rates and will likely shift from the current accelerating phase to a moderating phase in the second half of the year.

    US non-farm payrolls ahead of market forecasts; average hourly wages rising in-line with expectations

    The US non-farm payroll number on Friday was widely anticipated to be the most significant economic data release on the week. Market consensus was for a +720k rise in payrolls, which would have been enough to reduce the unemployment rate to 5.6%. The actual print came in at +850k, with the prior month also revised up modestly. Average hourly earnings were up 0.3% in the month, a rise of 3.6% year-on-year, in line with expectations and in keeping with base effects. This helped to offset the weaker ISM data point from earlier in the week and was taken positively by markets.

    Inflation key market theme despite below forecast European inflation print; market volatility continues to decline

    Inflation remains a key theme for markets more broadly; the European inflation print came in slightly below market expectations (1.9% versus 2.0% forecast). Commodity price pressure, however, has not shown signs of easing, with oil prices now 55% higher over 2021 and back to levels last seen in 2018. Crucially for markets, the main inflationary impulses remain concentrated in the more cyclically sensitive parts of the economy leaving the ‘inflation is transitory’ view of the major central banks intact.

    The slow grind higher in risk markets is illustrated by the steady decline in actual market volatility. Indeed, the Chicago Board Options Exchange Volatility Index (VIX) has now fallen to 15, its lowest level since March 2020. Corporate bond valuations are also very stable, with spreads on European investment grade indices trading in a +/- 1bp range on 97% of the trading days in 2021.

    Outlook: US FOMC minutes may provide more colour on central bank outlook; PMI and virus cases other key data points

    The minutes from the US Federal Reserve’s June meeting should provide more context to the perceived hawkish shift in the “dot plot” of future rate expectations at the June FOMC (Federal Open Market Committee) meeting. European Central Bank President Lagarde and Bank of England Governor Bailey are also speaking, with potential headlines from the ongoing G20 meeting in Venice; especially with regard to OECD negotiations on reforms to the global tax system. On the data side, global service and composite PMIs will be released. Lastly, the spread of the delta variant will continue to weigh on markets, with many countries potentially reintroducing or strengthening controls and restrictions.

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