Nothing To See Here
RANGE-BOUND TRADING Financial markets remain largely range bound. Equity markets seem to be marginally up on the w eek, while ten-year government bond yields in the UK and US are slightly higher after a week of choppy trading. After slipping earlier in the w eek, the US dollar has subsequently rebounded to a near four-week high against the euro and sterling, although it is still well below its levels of a few months ago. The latest US labour market report seems to have been too much of a mix of signals to induce a major move in markets as employment growth disappointed slightly but w ages grew by more than expected for the second successive month providing more evidence of inflation concerns. The big themes for markets continue to be those w e have talked about for the past few months. The strength and sustainability of the economic rebound, whether the present rise in inflation pressures w ill just be ‘transitory’ or prove to be more sustained?
Possibly most importantly, will these trends cause a significant shift in monetary policy from its current very accommodative stance?
Over the past week, May PMIs have confirmed that broad based rebounds in activity are still gathering pace across the UK, US and the Eurozone. They also posted warnings that a combination of rising commodity prices, supply side constraints and in some cases worker recruitment difficulties are pushing up prices. The coming w eek will see important data in both those areas with UK GDP for April and US CPI inflation for May. Meanwhile, the European Central Bank will review monetary policy in the first of a number of important monetary updates from major central banks over the next few weeks.
One thing that could dent optimism about the recovery would be adverse Covid-19 news. The past week has seen a further rise in cases in a number of countries, not least the UK where they are up almost 40%. Public Health England has confirmed that the so-called Indian variant of Covid-19 is now dominant in Britain and might carry with it an increased risk of hospitalisation. However, more positively, the number of vaccinations also continues to rise sharply boosting hopes that there will not be a corresponding acceleration in serious cases and hospitalisations. Some experts are still calling for at least some restrictions to be kept in place in England after 21st June but the government so far is keeping quiet on this.
ECB TO WAIT AND SEE FOR NOW
Next w eek’s ECB monetary policy announcement on Thursday takes place against a mixed economic background. Eurozone GDP fell in Q1 for the second quarter in a row . However, timelier indicators point to a rebound in Q2 w hich seems to be gathering momentum through the quarter. Moreover, annual CPI inflation moved up to 2% in May consistent with the ECB’s target for the first time since late 2018. Nevertheless, as ‘core’ CPI inflation is still below 1% it seems that the ECB remains some way away from reaching its target on a sustainable basis. That points to Eurozone monetary policy being left largely unchanged for now despite calls from some haw ks to end the phase of faster asset purchases that began in March. The consensus is that the ECB may w ait until September before doing this, although a seasonal tendency for purchases to fall over the summer months may complicate the picture. What seems more likely is that ECB President Lagarde comments w ill remain ‘dovish’, acknowledging recent new s but still noting downside risks. The ECB w ill also update its economic projections and may raise the economic grow th and inflation forecasts at least for the near term.
UK GDP & US INFLATION TO MOVE UP AGAIN
In the UK, April GDP (Fri) is likely to show the positive impact of the easing in restrictions w ith a third successive monthly pickup. Both unofficial indicators, such as the PMIs, and official measures such as retail sales point to a big rise. We look for a 2.8% monthly increase led by the services sector but with sizeable gains also seen in construction and manufacturing. That outturn would mean that the Bank of England’s forecast of 4.3% growth in Q2 will be exceeded even if output is flat in May and June. Moreover, given the further easing in restrictions further pickups in activity seem likely in those months. The other notable data release next w eek will be May US CPI inflation. The annual headline rate rose by much more than expected in April, to 4.2% its highest since 2008 led by energy prices. The ‘core’ rate, while still lower also moved up sharply to 3.0% led by an out-sized rise in used car prices. A further increase is expected for May with the headline rate forecast at 4.7% and the core measure at 3.4% providing a further signal of near-term inflationary pressures. US central bank policymakers have already said that they are comfortable with a period of above-target inflation given previous undershoots and that they expect the current acceleration to be temporary.
So a further rise next week does not necessarily imply that the Fed will soon move to a less accommodative monetary policy. Unless oil prices continue to rise sharply, May will probably be the peak rate of inflation for 2021. How sharply it then falls back, however, is uncertain. The Fed is clearly counting on the current pressures from commodity prices and supply chains easing and that a relatively high unemployment rate will keep wage costs under control. However, some businesses are already highlighting difficulties in recruiting staff and wage growth appears to be picking up. So these assumptions are set to be tested in the coming months. From this weekend, Fed policymakers will be in their silent period ahead of the policy update on 16th June and so we won’t hear anything near term about their policy intentions. Nevertheless, what the Fed intends to do next will be a key focus for markets in the weeks ahead.
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