Markets Doing What Markets Do



BONDS SHRUG OFF LATEST US CPI RISE Financial markets in general remain range-bound, with bonds shrugging off inflation concerns and longer-dated yields continuing to fall. Most notable is that, despite a further

stronger-than-expected rise in US CPI inflation and other evidence of near term inflationary pressures, US 10-year Treasury yields fell to their lowest since early March. UK gilt yields are also down on the week, as are yields in a number of other markets. This suggests that the guidance from the US Federal Reserve and other central banks that the current rise in ‘inflation’ will prove transitory may be having an impact.


Central bank policymakers have largely been silent this week, as they prepared for upcoming monetary policy meetings. One exception w as the Bank of England’s Haldane who warned that a tightening in monetary policy may need to be imminent if a more persistent rise in inflation is to be avoided. However, his comments seemed to have little impact even on UK markets, possibly because he will soon leave the Bank and was already known to be more ‘hawkish’ than fellow policymakers. The European Central Bank left policy unchanged at its latest update this week and largely maintained a dovish line. Next up is the US Fed, and the reaction of its policymakers to recent developments will be a key focus for markets . Meanwhile, the UK government is supposed to confirm on Monday whether the ending of restrictions in England will go ahead on 21st June. Unlike the previous moves, this seems to be in some doubt given the recent sharp acceleration in new Covid-19 cases. There continue to be indications that the vaccine roll-out is helping prevent the rise turning into a significant increase in more serious cases and hospitalisations. Nevertheless, media reports suggest that the government is considering retaining some or even all remaining restrictions for another two to four weeks. If so, they could face a difficult time in parliament, as some of their own MPs will likely object.


FED MAY BE READY TO START TALKING ABOUT TAPERING

A change in monetary policy is very unlikely at Wednesday’s Fed update. How ever, it seems probable that Fed w ill now make a small adjustment to its policy guidance. Up until now , the emphasis through the pandemic has been on policy being supportive of the economic recovery. In particular, Fed Chair Powell has repeatedly said in recent months that it is too early to even start “talking about talking about tapering asset purchases”. However, some Fed policymakers are now suggesting that those discussions should start soon and Powell may confirm that in his post-meeting press conference. The Fed seems unlikely to go further than that at this stage. Overall, the message will probably be that policy remains very supportive of the recovery and that this support will be retracted very gradually. However, the modest change in rhetoric may pave the way for more concrete proposals later in the summer, with the aim of ‘tapering’ beginning around the turn of the year. Fed policymakers will also update their economic forecasts. The last update in March showed a significant upgrade in growth projections and reduction in unemployment rate forecasts. The new ones will probably see further moves in those direction. Most crucial, however, will be what happens to the inflation and interest rate projections. Last time, most Fed policymakers expected that inflation would still be close to 2.0% even in 2023 despite the economy’s recovery and, as a result, did not see the need for a rate hike before 2024. This time, the inflation forecast for 2021 will probably need to be revised up because of recent high numbers, but the majority will probably still forecast that inflation will be close to 2% over the longer term. This assumption that current inflationary pressures will be ‘transitory’ means that, while interest rate expectations may be hiked modestly, an increase is still not likely to be forecast before 2023 and probably only one 0.25% move will be expected in that year.


DATA WATCHED FOR EVIDENCE OF INFLATION

In the US, retail sales are forecast to be unchanged in May for the second successive month, following a big rise in March. However, ‘core’ sales are predicted to be up by a solid 0.6%, so the weakness is expected to mainly reflect a big fall in car sales. It is unclear whether that is due to a cooling in demand after a strong spring or a lack of supply because of issues with parts, including semiconductors , but anecdotal evidence points more to the latter. Other reports, including May industrial production and housing starts, are expected to be consistent with solid growth, although the former may also be impacted by the parts issue.


UK consumer price inflation has been on the rise of late, but so far the move looks modest compared to rises seen elsewhere and particularly in the US. May CPI is forecast to show a further rise in annual headline inflation, up to 1.8% from 1.5% in April, and core inflation to 1.5% from 1.3%. That will still leave inflation slightly below the 2% target, although it may move up further in coming months. One determinant of that will be the outlook for the labour market, expectations for which have changed markedly in recent months due to a combination of the extension of the furlough scheme and strength of the economic rebound. A sharp rise in the unemployment rate is now no longer expected, even when the furlough scheme expires. Indeed, some recent business surveys have noted complaints of labour shortages. The latest labour market report, for the 3 months to April, is forecast to show a rise in employment of 125k, a fall in the unemployment rate to 4.6% (from 4.8%) and annual earnings growth up to 4.8% from 4.0%. Finally, we estimate that retail sales may have fallen by -0.9% in May following April’s 9.2% rise. That would still be consistent with strong underlying growth.


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