Strong economic data over the last week in the US, Europe and Asia appears to be confirming the perception among investors that a cyclical recovery is well established. As a result, valuations of risk assets have risen on the view that the pandemic will be overcome this year.
The last week has seen both record highs for US indices and a return to pre-pandemic levels for European gauges. This week, the STOXX Europe 600, the most widely quoted broad index of western European stocks, surpassed its February 2020 high. It has now recovered all the losses sustained from the pandemic. Its return to pre-pandemic levels comes some months after the US S&P 500’s advance. Nonetheless, it remains a surprisingly rapid recovery.
Financial markets continue to trade on the basis that it is safe to look beyond the various issues encountered with the vaccine rollout in Europe. The expectation is that Europe will put the pandemic behind it, just as the US and UK are perceived to be doing, before the end of the year.
Equity markets in the US and Europe were given a boost by the publication on 2 April of a favourable US employment report showing job creation in March far exceeded expectations. Non-farm payrolls rose by 916 000 (versus a consensus forecast of 660 000) after a 468 000 gain in February (figure revised up).
These numbers reflect the reopening of many sectors of activity thanks to the acceleration of the vaccination campaign in recent weeks. Nonetheless, more than 20 million US private sector jobs were lost last year. Job creation in February and March was mainly in the hospitality, restoration and leisure sectors. Construction jobs also rose in March as activity restarted after poor weather in February.
The improvement is beginning to spread across sectors and job types. It should also be noted that there are still two million people in ‘temporary layoffs,’ i.e., employees who are certain to get back to work when their employers resume business (see Exhibit 1). In the coming months, that number is expected to fall, resulting in significant new job creation. ‘Permanent’ job losses are falling slowly. They still stand at 3.4 million, which fully justifies the US government’s fiscal support measures.
Last week also saw the US Institute for Supply Management (ISM) manufacturing index soar to 64.7 in March (from 60.8 in February), marking its highest since 1983. This historical survey of purchasing managers reflects strong demand, but also points to many supply difficulties that are likely to lead to delivery delays and higher prices for raw materials. The ISM survey in the services sector (published 5 April) improved sharply in March with the index hitting an all-time high at 63.7 after 55.3 in February.
Data is showing a broad surge in manufacturing activity. In the eurozone, the results of the purchasing managers (PMI) survey for the manufacturing sector were slightly better than first estimated.
Economic sentiment as measured by the European Commission improved significantly in March for the eurozone, from 93.4 to 101, its highest since February 2020. Confidence in industry continued to rise and the climate in services recovered sharply.
The global manufacturing PMI reached 55, its highest in 10 years. The improvement is widespread: across the consumer, materials and capital goods segments.
Private forecasters have revised down their eurozone GDP growth forecasts for the first and second quarters of 2021, but are instead revising up their expectations for the second half of the year.
In the US, the consensus expects a solid recovery in activity as early as the first half of this year thanks to increased fiscal support. The Atlanta Fed’s GDPNow indicator, which incorporates all available data for a ‘real time’ GDP estimate, forecasts growth of 6% (annualised) in the first quarter (after 4.3% in the fourth quarter of 2020). The weekly activity index, calculated by the New York Fed, rose to well above its fourth quarter 2020 benchmark in early April.
Finally, the Bank of Japan‘s (Tankan) quarterly business survey beat expectations and showed an improvement in activity and the outlook for large manufacturing companies with a catch-up in the equipment sector. In the non-manufacturing sector, the improvement was slower, and a deterioration was seen in some activities (hotels, bars, restaurants), but the outlook is more encouraging. In addition, companies of all sizes and sectors are considering increasing investment in the 2021 fiscal year.
The healthy economic data, reinforcing expectations of a strong US economic recovery, has led markets to price in the first Federal Reserve rate rise as soon as 2022. Eurodollar futures now indicate the Fed will raise rates from near-zero levels currently by the end of 2022, with three additional interest rate increases priced by early 2024.
This stands in sharp contrast to the message from members of the US Federal Reserve, who recently reaffirmed their intention to keep rates on hold until at least 2024.
At a time when signs of accelerating global growth are multiplying and may justify somewhat higher bond yields, central banks will have to clarify their intentions in terms of monetary policy and the rate levels that they are willing to tolerate.
The market is likely to continue testing the Fed’s commitment to its new approach to monetary policy, which is based on the Fed allowing inflation to run above its longstanding 2% target to make up for prolonged periods of undershooting it.
The release of the minutes of the Fed and ECB meetings in March (on 07/04 and 08/04, respectively) will provide an opportunity to gain a better understanding of central banks’ message and how they view recent upward pressure on long-term interest rates and how they intend to respond to them (or not).
Federal Reserve Chair Powell could clarify his thinking in a global economy debate (08/04) at the IMF’s spring meeting.
Last week, President Joe Biden launched his much anticipated infrastructure package – the USD 2 trillion American Jobs Plan. Energy and climate spending featured prominently, dwarfing anything the US has seen to date. “The American Jobs Plan will lead to transformational progress in our efforts to tackle climate change,” said the president, when presenting the proposals.
While the new legislation is perhaps not the Green New Deal, which some groups in the Democratic party had hoped for, the numbers involved are nonetheless colossal. It sets a new benchmark for government expenditure on infrastructure and clean energy.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
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