Strong economic data over the last week in the US and Europe has reinforced the view among investors that the cyclical recovery is progressing. Ample liquidity continues to underpin valuations of risky assets.
New daily infections are on the rise. The rate of new cases globally hit a record last week with 5.2 million people infected, according to data from Johns Hopkins University. More infections in continental Europe, India and Brazil, and, more recently in the US, are behind the increase.
India is at its worst point in the pandemic based on infections and new cases are increasing. Brazil’s situation continues to deteriorate with the collapse of local health systems and daily fatalities still surpassing 3 000.
Despite the recent bounce-back in cases in Germany, fatalities in Europe have remained relatively low, although hospitalisations are now on the rise.
Despite some setbacks, markets are focused on the fact that in those countries that have vaccinated the largest shares of their populations, there have not been any developments to suggest that vaccination will not ultimately bring the virus under control.
The eurozone harmonised index of consumer prices (HICP) for March was broadly in line with market forecasts, but did move above 1% on a year-on-year basis for the first time since February 2020. This could suggest that the eurozone is joining the global inflationary rebound, where the expectation is for the number to continue to move higher this year.
This would push inflation expectations higher, anchoring a greater likelihood of the sustainability of higher inflation further out. However, disinflationary forces that may constrain any rise remain entrenched in the eurozone.
In the US, despite strong data for inflation and retail sales in March, US bond yields have fallen by 3 to 7 basis points over the last week. This may be due to the reflation trade being fully priced already.
The strong data on US consumer price inflation (CPI) also likely spurred some profit-taking in nominal bonds. US inflation-linked bonds did well, but swap spreads suffered as banks announced potential issuance schedules in their latest earnings releases.
President Joe Biden is expected to issue an executive order on “Climate-Related Financial Risk” ahead of the Leaders Summit on Climate on 22-23 April.
The gathering is a milestone on the road to the UN Climate Change Conference (COP26) this November in Glasgow and is designed to increase the chances of meaningful outcomes on global climate action at COP26.
It is expected that the executive order will give high-level direction on:
Policymakers at the European Central Bank have been unanimous in their support for accommodative monetary policy since the pandemic hit last year. At the ECB’s monetary policy meeting this week, there could be some discussion about scaling back the bond-buying programme. Action is, however, unlikely before the next meeting in June at the earliest.
The scaling-up by the ECB of its bond-buying activities via the pandemic emergency purchase programme (PEPP) has helped to keep borrowing costs low for governments, businesses and households in the eurozone.
Having expanded the size of the emergency bond-buying scheme twice in 2020, the ECB still has almost half the envisaged overall EUR 1.85 trillion left to spend under PEPP. The initial plan was to keep net purchases going until at least March 2022 and to stop only when the pandemic crisis is over.
However, some council members have suggested that the ECB should start reining in its bond buying sooner rather than later. We expect any such discussion to be deflected for now with the ECB council expressing cautious optimism on a strengthening of the eurozone economy in the second half of this year.
Last week, there were comments from Chair Powell of the US Fed and a detailed speech from Vice-Chair Clarida. The main takeaway for markets was that the Fed has nothing to say on the near-term policy outlook, remaining firmly focused on progressing towards its twin mandate goals rather than talking about them.
This can be taken to mean that the Fed is not ready to signal the start or even the thresholds for the process of tapering its asset purchases. The absence of news on this score was enough to take some expectations for rising policy rates out of pricing, with about 10bp of expected rate rises being taken out of prices through 2023, in line with the broader fixed income rally.
The Fed is now in a self-imposed news blackout ahead of the Federal Open Market Committee meeting on 27-28 April.
Preliminary purchasing manager indices (PMI) will be released this week across the G10 economies. Last week’s combination of strong economic data and what was likely profit-taking on consensus short US Treasury positions provided a positive backdrop for high-beta G10 currencies to rally.
To the extent that PMIs point to further upside surprises in activity data, last week’s risk-on price action could continue. This is likely to be conducive to further gains. Additionally, this week’s auction of 20-year US Treasuries will test market appetite for duration. A strong auction could prompt a further rally in yields of US Treasuries.
The preliminary Markit PMI for US manufacturing for April is likely to have remained elevated – the consensus is looking for a slight gain. Conditions in April were likely similar to those in March when manufacturers struggled to cope with supply constraints and an increase in new orders. The first two regional US manufacturing surveys for April have shown further gains from the already high levels.
While talk persists about equity market valuations, we expect the current liquidity levels to sustain demand in the economy and boost company earnings, thus supporting valuations. Moreover, higher inflation should continue to underpin corporate pricing power and hence earnings. Nonetheless, further equity upside depends on further upward revisions of earnings expectations.
Dispersion in equity performance has remained high across sectors and markets – US and US tech being the outperformers. COVID-sensitive sectors have continued to underperform. Value is likely to perform and valuations of European equities, which are more value-dominated, could well pick up as European stimulus and vaccination programmes gain ground in the second and third quarter of 2021.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
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