- Focus on inflation dynamics continues as central bank speakers reiterate consideration for tapering at later stage
- Reduced expectations of policy tightening support - a pro-cyclical stance; patience required for total return opportunities
- Vaccination progress currently outweighing variant impact in UK and US; renewed lockdowns in Asia
- Outlook: Busy week ahead as US labour market and global PMI surveys to update the evolving growth and inflation picture
Focus on inflation continues as central bank speakers reiterate consideration of tapering at later stage
Central banks continue to walk a fine line; on the one hand trying to reassure markets that current inflationary pressures are transitory and to be expected given the nature of the recovery, with higher yields a natural reflection of economic recovery rather than inflationary concerns. However, they are also trying to reassure markets they aren’t ‘behind the curve’ and will taper stimulus and tighten monetary policy when needed in the future and as such longer-term inflationary pressure won’t be allowed to rise unchecked. This cautious approach was summed up by Fed Vice Chair Clarida, who stated it’s possible that “in upcoming meetings, we’ll be at the point where we can begin to discuss scaling back the pace of asset purSo far the evidence supports the transitory argument, with the more ‘sticky’ forms of inflation (those goods in the US CPI basket that move more slowly, as measured by the Atlanta Fed), not exhibiting material upward pressure as yet; while those goods with more ‘flexible’ pricing reacting sharply to the ongoing recovery. The moves in government bond markets have been relatively muted, suggesting that, for now at least, central banks’ rhetoric is winning the argument.chases”.
So far the evidence supports the transitory argument, with the more ‘sticky’ forms of inflation (those goods in the US CPI basket that move more slowly, as measured by the Atlanta Fed), not exhibiting material upward pressure as yet; while those goods with more ‘flexible’ pricing reacting sharply to the ongoing recovery. The moves in government bond markets have been relatively muted, suggesting that, for now at least, central banks’ rhetoric is winning the argument.
Reduced expectations of policy tightening support a pro-cyclical stance; patience required for total return opportunities
With risk assets in both equity and credit markets taking their cue from the ongoing economic recovery and supportive financial conditions, a pro-cyclical stance in asset allocation remains warranted in our view. Despite the uncertainty surrounding the medium-term inflation outlook and the potential central bank response, the actual level of market volatility has remained low, with the VIX index falling back towards post-pandemic lows. Lower volatility environments tend to be less conducive to implementing certain option-based strategies and as such we are being patient in deploying capital in this part of the portfolio.
Vaccination progress currently outweighing variant impact in UK and US; renewed lockdowns in Asia
Vaccination progress continued to lend further support to the recovery story, particularly in the US and UK. With most adults having received at least one dose and secondary vaccinations continuing to rise, the gradual reopening of the UK and US economies remains on track. Even a modest rise in cases associated with the spread of the ‘Indian variant’ in the UK appears localised and dampened by vaccines given the age profile of cases. The picture is less positive in Asia and Australia, with Singapore strengthening its border restrictions and the Australian state of Victoria entering a 7-day lockdown as cases grow. Japan remains under a state of emergency, with the US announcing a ‘do not travel’ advisory notice, with only two months to go until the planned start of the summer Olympic games. The geographical divides created by the spread of virus and the pace of vaccinations will remain a key focus for markets, as will its impact upon the global supply chain.
Outlook: Busy week ahead as US labour market and global PMI surveys update the evolving growth and inflation picture
The latest US non-farm payroll (NFP) on Friday will be a data highlight next week, given the underwhelming release last month (+266k versus 1m consensus estimates). Since then there has been a raft of more positive releases, such as the weekly initial claims numbers that suggest the last NFP was a blip rather than evidence the US was facing labour shortages and supply constraints that would raise concerns of impending wage inflation. We also have the release of a range of global PMIs which should give an idea of economic momentum through Q2, as well as the European flash CPI print for May that may inform whether Europe is starting to see the same inflation spikes we are seeing in the US. Fed Chair Powell and ECB President Lagarde will also be speaking.
- Fed meeting minutes hint at a greater openness towards a tapering of its bond-purchasing programme
- Strong May PMIs show a rebound in activity, even with lockdown restrictions still in place in some areas
- Volatility in cryptocurrencies as the People’s Bank of China bans Bitcoin as a means of payment for goods and services
- Outlook: EU leaders meet for a European Council meeting in an otherwise relatively quiet week ahead
Fed meeting minutes hint at a greater openness towards a tapering of their bond-purchasing programme
Minutes from the latest US Federal Open Market Committee meeting hinted at a greater openness towards a tapering of the US Federal Reserve's (Fed) bond-purchasing programme. Some Fed officials have begun to argue for a reduction in bond purchasing if the economy continues to improve. However, the majority view is that the recent rise in inflation is temporary and that employment across the country needs to improve substantially before a change in monetary policy can be considered. There were increasing signs of this improvement on Thursday with the weekly jobless claims coming in at 444k, down from 478k the previous week. However, the non-farms payroll number for the month of May is the next big test, especially as the April print significantly missed expectations.
Strong May PMIs show a rebound in activity, even with lockdown restrictions not fully lifted in some areas
The May composite PMI in the eurozone rose to 56.9, above the consensus of 55.1. Despite lockdown restrictions still in place across Europe, activity continued to rebound. The index was lifted by a jump in the services PMI from 50.5 in April up to 55.1, while manufacturing was softer, falling to 62.8 from 62.9 last month. The UK PMIs followed suit with the composite rising to 62.0 vs 60.9 last month, but it was manufacturing that overshot expectations whilst the services component saw a small increase. Finally, in the US, the services component jumped to 70.1 (from 64.7 last month, and well ahead of market expectation). When combined with the small beat on manufacturing (printing at 61.5), the composite came in at 68.1.
Volatility in cryptocurrencies as the People’s Bank of China bans Bitcoin as a means of payment for goods and services
Whilst we do not invest in cryptocurrencies, or often write about them, the volatility seen in Bitcoin and other cryptocurrencies this week is worth a mention, not least because of the potential spill over into broader markets. Bitcoin, by far the largest of the cryptocurrencies by market cap, at one point faced losses of 30% in a single trading day. There wasn’t a particular catalyst behind this, but a number of things have gone against Bitcoin as of late, and news that the People’s Bank of China clamped down on its use as a means of payment for goods and services stoked fear that there could be a wider rejection from central banks and regulation headwinds ahead. Earlier this year we saw a retail trading frenzy in shares of GameStop wobble markets, resulting in a spike in equity volatility; so any spill over into broader markets, whilst limited for now, will be paid close attention to.
Outlook: EU leaders meet for the European Council meeting in an otherwise relatively quiet week ahead
It could be relatively quiet for markets next week without any major data releases or central bank decisions. The week following will see the release of the US jobs report, which should get a lot of attention given the large miss seen in April and the weight the Federal Reserve assigns to the labour market recovery. Otherwise, EU leaders are meeting in Brussels on Monday and Tuesday for a European Council meeting, where the agenda is due to include the COVID-19 response, climate change, Russia, and the Union’s relationship with the UK.
- There was strong inflation data from the US, however the Fed reiterates its view that inflationary pressures are expected to be transitory
- Equity markets fall from all-time highs on concern that inflation may lead to an earlier than expected reduction in policy stimulus
- Virus headlines remain mixed. Data volatility likely to feed through to market pricing which could create market opportunities
- Outlook: growth expectations to be guided by purchasing manager indices and inflation data from the UK and EU
There was strong inflation data from the US, however the Fed reiterates its view that inflationary pressures are expected to be transitory
The April CPI print from the US came in much stronger than expected, with +0.8% on a month-on-month basis versus the +0.2% expected. This in turn sent the year-on-year number to +4.2%, its highest level since September 2008. This sharp rise was largely driven by those segments of the economy that are more sensitive to easing lockdown measures such as airline fares, hotel and lodging and recreational services. The largest single contribution came from a 10.0% rise in used car prices, which added 0.3% to the core print. This likely reflects people needing to get back to work, but who are reluctant to use public transportation, as well as car hire companies rebuilding their rental fleets.
Although the stronger data was a surprise, Federal Reserve (Fed) members remained confident in their view that inflationary pressure would be transitory; Vice Chairman Clarida stated he expected “inflation to return to – or perhaps run somewhat above – our 2 percent longer-run goal in 2022 and 2023”. President of the Federal Reserve Bank of Atlanta, Raphael Bostic, added that he was “expecting a lot of volatility at least through September”. This view that inflation is transitory was supported by more benign rises from less COVID-sensitive components of CPI, with rents only up 0.2% for instance.
Equity markets fall from all-time highs on concern that inflation may lead to an earlier than expected reduction in policy stimulus
The path of future inflation remains a critical issue for markets; the Fed clearly expects inflationary pressure to come through over the short-term, but feels that spare capacity in the economy (such as unemployment or underemployment) would need to be eroded before longer-term inflationary pressures can arise. However, the longer inflation surprises to the upside persist, the more the market will focus on whether the extraordinary amount of policy stimulus should remain in place with the knock-on impact to government bond yields and risk assets. This concern was the primary driver of equity market weakness.
The lower-than-expected non-farm payroll data from the US on Friday (266k versus consensus estimates for a 1m rise) led markets to initially view the likelihood of policy tightening to be delayed, assuming the data pointed to a slower path to recovery. However, more detailed analysis of the data shows that the miss was more of an issue of a shortfall in supply, rather than any weakness in the demand for labour. Although unemployment remains above pre-COVID levels many firms are appearing to struggle to fill vacancies, potentially hindered by factors such as childcare needs (schools have still not fully reopened) as well as the stimulus cheques reducing the need to return to work immediately. This reduction in filling vacant positions is leading to short-term wage pressures forming, with the likes of McDonalds and Amazon both announcing more than 10% rises in hourly wages. Wage pressures remain a key long-term driver of inflationary pressure, so will be watched carefully over the coming months.
Virus headlines remain mixed; data volatility likely to feed through to market pricing which could create market opportunities
The spread of the virus through many emerging and Asian markets, such as India, remains concerning, with countries such as Japan expanding their state of emergency and lockdown measures which may tip economies back into recession. On a more positive note the UK announced a relaxation of restrictions and the US declared that fully vaccinated citizens would no longer need to physically distance or wear masks; another milestone on the road to normality.
Mixed headlines in both the spread of the virus and the underlying economic data is feeding through to higher market volatility, with the Chicago Board volatility index (VIX) rising from 17 to 28 during the week, its highest level since early March. Although these spikes in market volatility feed through to lower asset prices, they also provide opportune moments to implement total return strategies at more advantageous terms.
Outlook: growth expectations to be guided by purchasing manager indices, inflation data from the UK and EU
The next week is relatively quiet in terms of data releases, although the flash purchasing manager indices for May will be released towards the end of the week, as will the final few corporate earnings releases. The market will undoubtably focus on any data or speeches by policymakers that focus on the likely path and impact of inflation over the coming months; with both the UK and the EU set to release April CPI data on Wednesday.
- The US jobs report comes in below market expectations, and the Fed stays on message with regards to monetary policy.
- Q1 earnings: concerns of pricing pressures and supply bottlenecks temper otherwise positive management commentary.
- Outlook: key data releases from the US including retail sales, industrial production and April CPI.
The US jobs report comes in below market expectations; the Fed stays on message with regards to monetary policy
The market continues to assess when strong economic data releases and inflationary pressures will result in the Federal Reserve (Fed) changing their policy stance, so statements from the Fed and a disappointing non-farm payrolls helped to abate fears of a tightening monetary policy in the near term. Fed Chair Powell said that a string of months like March is needed before the Fed’s goals are achieved. Fed Governor Bostic noted that we are not out of the woods and the committee would not formally discuss the pace of bond purchases. With the Fed staying on message, pressure was relaxed ahead of Friday’s US non-farm payrolls report where market expectations were for a further 1m jobs to be added. The change in non-farm payrolls came in at 266k, materially undershooting expectations and bringing into question the pathway of the labour market recovery. The Fed have been consistent with the message that they want to see actual rather than simply forecasted progress, and this latest data release likely indicates delays in the trajectory of the economic recovery.
Q1 earnings: concerns of pricing pressures and supply bottlenecks temper otherwise positive management commentary
We are now through the bulk of corporate reporting for Q1 in both US and Europe. The most notable takeaway from the earnings season so far has been the sheer scale of beats. Headline earnings per share growth for the S&P 500 is now running at +46% year-on-year in the US. That is a significant beat on pre-season expectations for +20%, and this expectation had itself been revised up more than any other quarter on record. The trend is similar in Europe where earnings per share growth is currently running at +41% year-on-year, surprising positively by 18%. As usual, the biggest focus was on the five mega caps reporting and the latest results reaffirm why the market places such a high multiple on them. Highlights include Amazon revenue topping $100bn for the second quarter in a row, Apple revenue growth of more than +35% across all geographies and Alphabet announcing a $50bn share buyback programme. Indeed the five largest companies in the S&P 500 now account for 25% of total index market cap (c$8trn) and the combined annual revenue is comparable to the GDP of countries such as the Netherlands & Mexico.
In terms of market reaction, share price moves following results were notably muted, showing the high bar set for earnings growth this year. The impact of supply disruption was a key theme from management commentary across the board. Industrial bellwether 3M commented that it expects costs of raw materials & labour to be a significant drag this year while the largest consumer staples name Procter & Gamble, warned that it would be raising prices due to higher input costs. On a similar note, a wide spectrum of companies highlighted supply disruption caused by chip shortages with companies as wide ranging as Ford, Caterpillar & Apple all citing an impact. In summary, the earnings season has been very strong and management commentary very positive on the demand outlook, however our key focus will be on how ‘transitory’ the impact from pricing pressures and supply ‘bottlenecks’ are in a broader macro context.
Outlook: key data releases from the US including retail sales, industrial production and April CPI
It may be a quieter week for markets next week with the main focus on data releases. A number of key prints from the US should aid in assessing the strength of the economic recovery and what level of inflationary pressures are coming through. This in turn can help to form a view of when the Federal Reserve will start paring back monetary stimulus. However, comments from the Fed and the disappointing jobs report this week may push those discussions back a few months.