Solid U.S. economic growth indicators, along with dovish Fed comments, continued to support global equities last week – helped by a further stabilisation in bond yields despite simmering U.S. inflation concerns. The U.S. ISM service sector index soared to 63.7 in March (from a still strong but weather-affected 55.3 in February), with the price component up to 75 (the highest since June 2008) as rising energy costs and temporary supply chain bottlenecks created pricing pressure. Adding to market angst, U.S. producer prices rose a stronger than expected 1% in March to be up 4.2% over the year.
Investors, however, are trying to shrug off the inflation concerns – as evident with a solid 2.7% gain in the S&P 500 last week to record highs and a modest decline in U.S. 10-year bond yields to 1.66%. Fed commentary continues to suggest that any near-term lift in inflation is likely to be transitory, with the minutes to the latest Fed meeting indicating it will be “some time” before a tapering in bond purchases is contemplated.
The market’s inflation tolerance will again be tested this week with the release of the U.S. March consumer price index on Tuesday. Reflecting higher energy costs, annual headline inflation is expected to jump to 2.5% from 1.7%, though the core-CPI (excluding food and energy costs) should remain more benign, only jumping from 1.3% to 1.6%. Economic strength should also be evident in Thursday’s retail sales report, which is expected to show a 5.5% surge in spending during March after a 3% (weather and lockdown affected) slump in February.
As if the market needed further support, this week also sees the start of a likely upbeat U.S. March quarter earnings reporting season – led, as usual, by the banks. According to FactSet, current expectations have earnings rising by 24.5% on COVID-depressed levels this time last year. Of course, the main focus will be outlook statements and the extent to which actual earnings beat market expectations. Given the strong economic backdrop, it seems unlikely that the earnings season over coming weeks will disappoint – though one potential risk is any corporate commentary suggesting undue price and/or wage pressures.
Global equity trends
Japanese post-COVID outperformance has come off the boil a little in recent weeks, with the U.S market again strengthening. Not helped by a correction in Chinese equities, emerging markets are also on the back foot. Meanwhile, the recent stabilisation in bond yields and oil prices has allowed growth to outperform value for the second week in a row.
Despite some disappointing news on the vaccine front, and after having stubbornly moved in a sideways range since mid-February, the local equity market pushed higher last week, with the S&P/ASX 200 hitting its highest levels since the COVID crash last year. As has been evident globally, the recent move higher has been most evident in growth sectors, with both technology and consumer discretionary doing well. Bond yields and the $A have also corrected back somewhat in recent weeks.
Apart from vaccine delays, the only other notable development last week was the RBA meeting – which doubled down (tripled down?) on the Bank’s view that it will keep policy expansionary for some time. For policy aficionados, the current interest is whether the RBA will eventually roll its 0.1% yield target from the August 2024 maturing bond to that of November 2024 and if and when it announces ‘QE3’, or another $100 billion in bond purchases as the second $100 billion bond buying tranche rolls out. Both should likely happen in coming months, unless the RBA suddenly wants to signal a tapering in its ‘unconventional’ policy measures – which in turn likely won’t happen until other central banks (especially the Fed) make similar noises.
That said, I do anticipate macro-prudential controls will be re-introduced later this year to deal with a very hot housing market. To this end, the RBA Statement last week added that it would be “monitoring trends in housing borrowing carefully.”
We should expect more news of local economic optimism with the NAB and Westpac surveys of business and consumer sentiment on Tuesday and Wednesday respectively. On Thursday, the March labour market report is expected to show a further solid 35k rise in employment with the unemployment rate down to 5.7% from 5.8%.
While the expiration of JobKeeper at the end of last month may well produce somewhat softer employment reports over the next few months, there appears enough underlying momentum in the economy to quickly absorb the around 10% of the 1m affected workers (100k) estimated as likely to find themselves seeking new employment.