Sterling's Bull Run Ends
CENTRAL BANKS PUSH BACK ON RISING YIELDS
Global bond yields soared over the past week, with US 10-year Treasury yields peaking above 1.60% and their UK counterparts above 0.80%. In Australia, 10-year government bond yields climbed to near 2% (Chart 1). To the extent that the increases represent expectations of economic recovery, they should in principle be welcomed by central banks. That appeared to be one of the main messages from US Federal Reserve officials. Bank of England Deputy Governor Dave Ramsden also said rising UK yields reflect positive news on the economy.
However, there are concerns that the increases in bond yields have occurred too quickly and could dampen recovery prospects if they are transmitted to the wider economy or hamper the ability of fiscal policy to provide ongoing support. After all, while the US economy is expected to continue to grow in the current quarter, Q1 contractions are forecast for the Eurozone and the UK mainly as a result of the restrictive lockdowns still in place.
Global equity markets have fallen significantly this week, while the US dollar gained. Sterling peaked above $1.42 and €1.17, but fell back below $1.40 and to €1.15. Markets will be watching to see if the US central bank pushes back more firmly in the coming week on the recent rises in Treasury yields. ECB officials have already warned against rising Eurozone yields with the economy remaining ‘fragile’, while the Reserve Bank of Australia announced unexpected bond purchases. Next week, Fed Governor Brainard (Tue) and Chair Powell (Thu), among others, are scheduled to speak on the economy.
SUNAK’S BRIDGE TO RECOVERY
Notwithstanding the week’s market moves, low debt servicing costs provide leeway for UK Chancellor Rishi Sunak to extend the government’s emergency support measures at next week’s Budget (Wed, about 12:30pm). Government borrowing has surged over the past year and there is speculation that the Chancellor may provide some ‘tasters’ of tax increases, including corporation tax, to signal the desire to return public finances onto a more sustainable footing. Nevertheless, it makes sense for now for the focus to remain on bolstering the recovery and limiting potential economic scarring, especially given the cautious unwinding of restrictions in PM Johnson’s four-step roadmap out of lockdown. The OBR’s economic growth forecast is expected to be revised up, helped by the impact of the vaccine rollout.
Media reports suggest that the Chancellor may announce a replacement of emergency lending schemes with a new UK state-guaranteed loan programme with stricter criteria. The furlough scheme could be extended beyond April as it has helped to prevent a much sharper rise in unemployment. Other measures to be considered include business rates relief, the VAT reduction for hospitality and the stamp duty holiday. There will probably be more speculation on policy measures over the weekend and early next week.
US LABOUR MARKET SLACK
In the US, the long-awaited $1.9 trillion fiscal stimulus package has yet to be approved by Congress. It will probably be voted on by the House of Representatives later today before it goes to the Senate, although the timetable for the latter is not certain and a potential compromise on federal minimum wage provisions between the two chambers could further delay the bill’s passing.
There have been some reservations, notably from former US Treasury Secretary Larry Summers, that size of the fiscal package may be excessive and may lead to excess inflation. Nevertheless, the Fed has maintained that policy support – both monetary and fiscal – remains necessary to secure the economic recovery, especially as the unemployment rate remains high and could be understating the true scale of joblessness due to people dropping out of the labour force.
So far, the US labour market appears slow to respond to economic growth which has picked up again after slowing sharply in late 2020 in the wake of rising Covid-19 infections. Latest weekly initial jobless claims figures dropped by more than expected, but the recent trend has been running well above that seen last autumn.
Consequently after December’s 227k fall in employment and a disappointingly small 49k rebound in January, we expect February payrolls (Fri) to rise by a relatively small 145k, well down on the rises seen last autumn. Moreover, we also expect the unemployment rate to rise to 6.5% from 6.3% last month. These outturns would likely be seen by Fed policymakers as confirmation that there is still a lot of slack in the economy.
ECB LOOKS THROUGH HIGHER INFLATION
Elsewhere, Eurozone ‘flash’ CPI inflation (Tue) for February may show a slight rise to 1.0%y/y after the jump up to 0.9%y/y in January. The boost from energy price effects may be partly offset by lower core goods inflation evident in released figures for France. Energy is expected to drive headline inflation higher in the coming months, but the ECB will probably insist that temporary increases do not constitute a sustained return to its goal of “below but close to 2%”. As noted above, the ECB has been less sanguine about recent rises in government bond yields than their US counterparts, perhaps reflecting continued downside economic risks due to the relatively slow start to the vaccine rollout.
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