Global equities managed to shrug off further upward pressure on bond yields last week, as the combination of strong economic growth yet tame inflation results buffeted investors.
The S&P 500 Index rose 2.6% even as U.S. 10-year bond yields lifted 6 basis points to 1.63%. The U.S. February consumer price inflation (CPI) outcome was no worse than expected, with core annual inflation holding at 1.4%. Bond markets were also pacified somewhat by reassuring comments from the European Central Bank to the effect that it would step up bond buying to contain any destabilising rise in yields. Contrary to fears, key 10-year and 30-year U.S. Treasury bond auctions met reasonable demand, especially the former.
That said, other data suggests the global economy is roaring back with added fiscal policy stimulus throwing petrol on the flames. U.S. weekly jobless claims dropped to 712k last week from 754k, suggesting labour market improvement is reaccelerating after the Xmas/New Year COVID third-wave lull. Meanwhile, U.S. President Biden’s $US 1.9 trillion stimulus bill was signed into law, meaning around 85% of households will soon start receiving one-off payments of up to US$1,400. The OECD reckons this stimulus could add around 3% to U.S. economic growth this year, which is why it upgraded its U.S. 2021 growth forecasts from a strong 3.2% to a blistering 6.3% in last week’s updated Economic Outlook.
Can all that growth take place without adding to inflation? The Fed thinks so, but the bond market is not so sure. As evident in the chart below, the result is that the market is now pricing in the beginning of Fed policy tightening by mid-2022, whereas virtually all voting Fed members reckon it won’t happen until 2023 at the earliest. Were the market as sanguine as the Fed, my modelling suggests U.S. 10-year bond yields should not push much past 1.5% – which would be a relief for Wall Street. While I side with the Fed, how this showdown plays out over the short run remains to be seen, as U.S. growth data is likely to ramp up in the months ahead and, as alluded to last week, annual U.S. consumer price inflation is also likely to step up for at least a few months due to the base effects of very low COVID-related readings around this time last year.
The Fed vs. Market Showdown
In other news, iron-ore prices took a breather last week as China announced some curbs on steel production to limit pollution. More broadly, Chinese stocks have also tumbled of late due to both rising global bond yields and talk of credit tightening. All this is consistent with my view that iron-ore prices should retrace back to around US$100/tonne later this year (weakening the $A) as China’s industrial-heavy COVID-related stimulus unwinds.
A focus this week will be on Wednesday’s Fed meeting, and specifically what if any concern Powell expresses about the recent rise in bonds yields. To my mind it seems unlikely the Fed will feel compelled to step up bond buying. Instead, it might reiterate its view that any near-term lift in inflation should be temporary and it still sees little need to consider raising rates for some time. As a sop to the market, it might even go as far as to suggest potential further bond buying if the rise in bond yields became somewhat more destabilising for markets and the economy.
Of course, the Fed’s ‘dot plot’ of voting member policy expectations will also be released, and there’s a risk of bond market mayhem if a few more members pencil in tightening next year.
Global equity trends
In terms of global equity trends, value only modestly beat growth last week, with investors in tech stocks unsure whether to buy the dip (as was evident earlier in the week) or join the stampede into value stocks. Weakness in Chinese stocks has helped undermine emerging market performance in recent weeks. Europe, meanwhile, is displaying a bout of outperformance as the Continent attempts to shake-off COVID-related restrictions.
As expected, local business and consumer sentiment data last week was upbeat, suggesting confidence levels across the economy are at decade highs. Also, as I’ve been expecting, the Federal Government unveiled a more targeted $1.2 billion tourism package as partial replacement to the more broadly based JobKeeper program. We can apparently get a 50% discount on plane tickets to select regional destinations between April and July – though I wonder if airlines won’t just double their advertised rates! Local stocks inched ahead 0.8% while, perhaps encouraged by RBA Governor Lowe’s reiteration of a steady policy outlook, bond yields dropped back despite the lift in US yields.
This week’s data highlight is the February labour market report on Thursday. Another solid employment gain of around 30K should be expected, with the unemployment rate dipping from 6.4% to 6.3%. Of course, the real test for the employment market will be the loss of JobKeeper at the end of this month, given that around 1 million workers are still on program. To my mind, the economy has enough momentum to deal with this transition, and most (though not all) of these workers should retain their jobs. This suggests removal of JobKeeper should be a speed bump rather than a road block to the ongoing recovery.