Keeping a weekly column like this one going brings home the sense of immediacy that frequently grips financial markets and that can fuel short-term spikes or dips as we have seen recently in US bond yields. While of course we understand such movements, it is good to take a step back so that we can analyse what is driving central bank thinking at the moment.
Taking the 2 March closes as the starting point, the latest moves in equities and bonds have echoed what we saw in the second half of February – although in a far less orderly fashion.
Long-term bond yields rose (by 14bp for the US 10-year T-note yield to 1.53% on 9 March; by 5bp for the 10-year Bund yield to -0.30%).
Global equities fell, by 0.6% for the MSCI AC World index in US dollars terms. In the US, the NASDAQ Composite index fell to its lowest since mid-December on 8 March. It regained 3.7% the following day, but still lost 2.1% over the week.
So what is the context for these recent developments?
With daily COVID-19 infections falling in the US, the UK and Spain, but rising in Italy and Germany and still high in France, investor attention is focused on how vaccination programmes are progressing.
Overall, they are going rather well – and bringing promising results. Despite some delivery and administration delays, governments’ vaccination targets at least now seem credible. Furthermore, studies are consistently showing that the vaccines are protecting against serious variants of the virus as well as limiting contagion.
This good news means a return to normality is in sight, although it may still seem far off for anyone eager to book a holiday already now, as well as for hospital care-givers and workers in the retail, hospitality, travel and entertainment sectors that remain closed.
On the economic front, the promising news on vaccinations has resulted in a significantly sharp upward revision to growth forecasts for 2021. In its latest Economic Outlook, the OECD pointed out that ‘global economic prospects have improved markedly in recent months’.
Global growth for this year has been revised from 4.2% (in its December forecast) to 5.6%. The report said global output could exceed its pre-pandemic level by mid-2021, although it stressed that there would be divergences between countries and sectors.
In this regard, the main upside and downside risks mentioned in the OECD’s report relate to the pace and success of vaccination programmes. What is not headlined are the risks of economies overheating and accelerating inflation despite these issues having dominated bond market attention for several weeks now. What the report does emphasise is the importance of sustained fiscal and monetary support.
The latest US jobs report showed that private sector net job creation in February at 465 000 far exceeded market expectations (+200 000 as per the Bloomberg consensus). This upside surprise arose from the recovery of sectors most affected by the pandemic (for example, a net 286 000 jobs were created in bars and restaurants). Temporary help services also gained. Traditionally, this is a positive sign for the labour market as a whole.
We expect job creation to remain dynamic in the coming months as vaccination advances allow for a recovery in many other sectors, but the labour market is still a long way from full employment.
One business survey shows that there are 9.5 million fewer jobs compared to the pre-pandemic period. More worryingly, because it highlights structural weakness, the household employment survey reveals that 5.5 million people have left the labour force compared to February 2020. More than half of them – three million – were women (see Exhibit 1) and these workers are typically slower to return to the labour market than men.
We believe these numbers fully justify the Biden administration’s ambitious multi-trillion dollar fiscal stimulus given that it will be difficult to get people back to work. If as a result, the US economy does overheat, it will have been allowed to do so to restore full employment.
Already on 7 February, Treasury Secretary Janet Yellen reminded market observers that the support package was intended to ‘speed the recovery’ and should help a return to full employment in 2022 rather than 2025, which would likely be the case were no measures to be taken.
Inflation concerns will not simply fade away, especially as price indices remain distorted by various factors. For energy prices, base effects will come into play. Even if these issues are temporary, we are likely to see further nervousness in bond markets in the short term, with possible implications for equities.
Central banks can typically cope with a gradual and reasonably orderly rise in long-term bond yields as long as it does not jeopardise the economy’s favourable financing conditions. Explicitly setting an upper limit on long-term bond yields is probably not the best strategy, at least in the near future.
For central banks, repeating that pre-emptive policy rate increases are no longer on the agenda is much more important, especially for the US Federal Reserve. In fact, market expectations of a foreseeable interest-rate increase that have crept into bond pricing recently do not appear to match with the Fed’s new monetary policy framework.
In this context, investors could benefit from the best of both worlds: A cyclical recovery that should become increasingly visible in the coming months and be accompanied by a still accommodative monetary policy. A return to normal, yes, but a controlled one, and thus favourable to risky assets.
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