Last week many equity markets again advanced as investors appeared relaxed around inflationary pressures, and dovish rhetoric from central banks eased any nerves caused by stronger macro data. Last Thursday, the focus was on the US Consumer Price Index (CPI) data and the European Central Bank (ECB) meeting. The MSCI World Index traded up 0.5%, the STOXX Europe 600 Index +1.1%, the S&P 500 Index+0.4%, and the MSCI Asia Pacific Index, -0.2%.1
Inflation Remains the Key Talking Point
As has been the case for much of 2021, the debate over rising inflationary pressures and the reaction from central banks dominated headlines last week as we had key US inflation data and an ECB meeting.
US CPI data came in at +5.0% year-on-year (y/y), which was the largest annual gain since August 2008. Core CPI (excluding food and energy) was at the highest level since 1992.
However, looking into the numbers, there did appear to be temporary factors driving this, something that tied in with the Federal Reserve’s (Fed) recent narrative that the current inflation surge is “transitory.” Within the data, “previously owned cars and trucks” accounted for about one-third of the total monthly advance, which is being driven by the chip shortage which should eventually correct itself. Air travel was also a factor, due to the reduced capacity that airlines are running. Finally, there was a slower month-on-month (m/m) pace of increase, with headline CPI up 0.6%, and excluding food and energy up 1.1%. There do seem to be some signs inflation could be easing.
Given the presence of some temporary factors driving inflation data, the markets are telling us investors are happy to run with the Fed’s narrative that inflationary pressures are transitory. We see this view reflected across asset classes. US equity markets remain near all-time highs and US bond yields tightened last week, with the US 10-year Treasury yield at 1.49%, its lowest level in three months. Often a “canary in the coal mine,” credit markets are not showing signs of stress either, with high-yield spreads remaining tight.
This Wednesday we have the June Fed meeting, so we will have further clarity on Chair Jerome Powell’s thinking. However, with steady performance across asset classes it feels like investors are not expecting much of a change in tone. Looking ahead, the key dates may be the central bankers’ summit in Jackson Hole, Wyoming, at the end of the summer, and the September Fed meeting.
ECB Remains Dovish Despite Improving Picture
The ECB stuck with its accommodative stance last week, keeping policy unchanged despite an improving economic outlook for the region. Interest rates stayed on hold and the ECB stated that the pandemic emergency purchase programme (PEPP) asset purchases would be significantly greater than the first quarter (as stated before) and around the current pace of €20 billion a week (in line with expectations).
In terms of outlook, the ECB now projects a “sizeable improvement in activity in the second quarter” followed by further robust recovery in the second half of the year. The central bank sees gross domestic product (GDP) of 4.6% (up from 4.0% in the March projections) for 2021 and 4.7% (instead of 4.1%) for 2022. The ECB now expects 1.9% (instead of 1.5%) for 2021 and 1.5% (up from 1.2%) for 2022. For 2023, the ECB left its call unchanged at 1.4%. These predictions are below its 2% target for inflation.
Last week also saw positive outlook from Germany’s Bundesbank, which upgraded its growth forecasts to 3.7% this year versus prior 3.0% estimate, and 5.2% for 2022 versus 4.5% prior.
This sets up a supportive backdrop for European equity markets and, with the European Recovery Fund due to impact in the second half of the year, many investment banks continue to push European equities, noting rising vaccination rates should support economic activity as the European Recovery Fund kicks in.
The Week in Review
This week saw European equities grind higher to make fresh all-times highs, with the STOXX Europe 600 Index up 1.1%. This was the fourth consecutive week of gains. Once again, European equities outperformed other regions, with continued focus on an improving macro backdrop thanks to accelerating European vaccination programs, declining COVID-19 cases (excluding the United Kingdom) and the imminent distribution of the European Recovery Fund. With that, European equities saw a ninth straight week of inflows. The main talking point was last Thursday’s ECB meeting which saw accommodative policies remain on hold, despite a more optimistic outlook.
Health care outperforms: There was a less familiar look to sector performance. Health care stocks had a rare day in the sun as this sector has been a major underperformer over the past year for well-documented reasons. It felt like the Biogen Alzheimer drug news was a catalyst for some to look at the sector, particularly considering the underperformance. Tighter US yields this week have also helped. The feedback is that a lot of faster money is chasing the space this week given it is a big underweight, so it remains to be seen whether the move has legs to last longer.
Resources, chemicals and banks were the laggards on the week, with headwinds in tightening yields and the ECB remaining accommodative for banks. The banking sector remains second best year-to-date (automobiles are in the lead) so an element of investor profit- taking isn’t a surprise.
From a country perspective, Switzerland’s equity market was an outperformed thanks to health care strength. Italy’s FTSE MIB Index broke out to levels not since the 2008 global financial crisis last, as optimism regarding Italian equities grows.
The German DAX was left behind last week with meagre gains of 0.3% as the reflation trade ran out of steam. A clear example of this dynamic was the Goldman Sachs EU Reflation basket, which was one of the worst performing factors last week, down 0.4%.
In the United Kingdom, we continue to see decent macro data, with the UK economy growing 2.3% in April m/m (in line with expectations). However, it is worth keeping an eye on the rising COVID-19 cases driven by the new Indian/Delta variant, which is 40% more transmittable. The United Kingdom reported 8,125 more COVID-19 cases last Friday vs. an average 2,000 a day around a month ago. This wave will be a key test for the vaccination programme and whether the country can succeed in breaking the link between rising cases and hospitalisations.
Numbers in hospital are still low but edging higher, so it looks likely the further easing planned for UK lockdown on 21 June will be pushed out by about four weeks. The market feels relaxed that reopening will continue steadily, and we won’t see a return to lockdowns, so any shocks here could see sharp pull backs for reopening names.
The S&P 500 Index edged higher in what was a quiet week aside from the noise around the CPI data last week. Evidence of this muted performance is the limited number of days with moves over 1% in recent months.
Looking at sector performance, health care outperformed (+1.9%) thanks to the strength in Biogen. Financials lagged (-2.4%) as yields tightened.
In last week’s update, we highlighted some data around the improving finances of the average US household and how that could boost the US economy. On Thursday, the Fed released data that showed the net worth of US households climbed to new heights as 2021 began and the effects of the COVID-19 pandemic began to fade. Thanks largely to a surge in the stock market, the total balance sheet for households and non-profits rose to US$136.9 trillion in the first quarter, a 3.8% gain from the end of 2020, according to the Fed.
The G7 summit, held in the United Kingdom last week, was notable. We saw high levels of engagement from the United States, a sharp contrast to the prior administration. Much of the focus was on climate change and efforts to counter the influence of China.
Asia and Pacific
Last week was quiet for Asian markets with the MSCI Asia Pacific Index down 0.2%. Index performance was tightly grouped with the Japanese Nikkei unchanged, Shanghai Composite down 0.1% and the Hang Seng down 0.3%.
In Japan, the focus is on the vaccination program where the pace has picked up. With that, the reopening theme was back in play with sectors like transport, real estate, and land transport showing strong gains. We also had Japan’s first-quarter gross domestic product down 1.0% quarter-on quarter.
The tone of the G7 conference was a focal point, as G7 nations took a strong stand against China’s economic aspirations and human rights practices. US President Joe Biden declared there’d been “plenty of action” on Beijing, including offering an alternative to the sweeping “Belt and Road” initiative.
That said, there were talks last week between China’s Minister of Commerce, Wang Wentao, and US Secretary of Commerce, Gina M. Raimondo. According to press reports, Wang and Raimondo stressed the importance of dialogue and communication between China and the United States in the business field and agreed to promote the healthy development of pragmatic cooperation on trade and investment while properly handling differences. The two sides also agreed to maintain communication in their working relationship.
The Week Ahead
It should be a quiet start to the week with a number of markets in Asia (including China) closed Monday. Focus for the week will no doubt be on the Fed meeting, which concludes on Wednesday. In Europe, Norway and Switzerland are set for monetary policy decisions.
In terms of macro data, UK and EU CPI data will be a focus, and European industrial production will be closely watched, too.
The Biden-Putin summit on Wednesday could provide us with some drama.
Monday 14 June
- Eurozone industrial production (IP)
Tuesday 15 June
- Germany CPI
- UK claimant count and International Labour Organisation unemployment rate
- France CPI
- Italy CPI EU harmonised
- Eurozone trade balance
- US Purchasing Managers’ Index (PPI) final demand
- US industrial and manufacturing production
Wednesday 16 June
- UK CPI & Retail Price Index (RPI)
- US FOMC Projections
- Chinese retail sales and IP
- Japanese trade balance
- US President Joe Biden will meet Russian President Vladimir Putin in Geneva
Thursday 17 June
- Norway policy rate decision
- Eurozone EU27 new car registrations
- Eurozone CPI core and construction output
- US Jobless claims
Friday 18 June
- UK retail sales
- Germany PPI
- ECB current account
- Japanese CPI
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