Bond Yields Plummet

BOND YIELDS SLIDE SHARPLY The past week has seem some significant moves in markets. Possibly the most notable has been a big fall in bond yields. Less than four weeks ago, the US Federal Reserve’s monetary policy update seemed to stoke fears of rising inflationary pressures and an earlier than expected tightening in monetary policy. How ever, since then, US longer-term Treasury yields are down sharply and this w eek, 10- year yields touched their low est level since mid-February. Other bond markets, most notably UK gilts, have also seen sizeable declines in yields. Equity markets in contrast, seem set to finish do n on the w eek. How ever, in most cases the declines are relatively modest with US indices in particular still close to all-time highs. Currencies have been volatile as markets struggle to work out the relative implications for different countries of recent developments. The release on Friday of weaker-than-expected May UK GDP data initially added to recent sterling weakness but it has subsequently recovered and seems set to end the week unchanged. A number of explanations have been given for recent developments. Some see it as sign of growing market conviction that central banks are right in saying that the present rise in inflation is ‘transitory’ and that as a result monetary policy can stay very easy. Others noting the recent sharp rising in Covid-19 cases detect concerns of a slow-down in growth in the second half of 2021. There is some support for this in recent evidence of a rollover in Chinese economic data. Possibly in response China’s central bank has cut its reserve requirement, although it has subsequently said that this does not represent a move to ‘less prudent’ monetary policy. The comings w eek’s economic calendar has both data and events that may support or contradict both of these theories. There w ill be inflation updates in the US and the UK, while Fed Chair Pow ell w ill testify to Congress on monetary policy and may give more insight into policy intentions. Finally economic activity data in China, US and the Eurozone will provide new indications on the strength of the recovery.

MIXED NEWS LIKELY ON INFLATION

Next w eek’s US June CPI report may show a modest fall in annual headline inflation. So far this year, annual inflation has risen sharply from 1.4% in January to 5.0% in May. Next w eek’s release may show a small decline to 4.9%. How ever, the monthly rise in prices is still expected to be 0.5%. Moreover, ‘core’ inflation is predicted to be up 0.4% on the month and 4.0% from a year ago (3.8% in May). So it will still be far from clear that inflation pressures are easing. By contrast, in the UK, annual CPI inflation is expected to have risen further in June. We look for an increase to 2.3% (from 2.1% in May), with the ‘core’ measure also up to 2.2% (from 2.0%). Recent easing of restrictions point to additional uncertainties around pricing and so a higher than usual possibility of a surprise. Thursday’s labour market report w ill be watched for further indications on UK inflationary pressures. Business activity surveys continue to highlight difficulties in recruitment with resulting upward pressures on w ages. How ever, any sign of this in the upcoming report may be swamped by methodological changes due to the difficulties of collecting during the pandemic. That seems likely to lead to a downward revision in the estimated level of employment and possibly a small rise in the unemployment rate. Annual earnings growth is forecast to be up sharply in the latest reading for May but that may also reflect data distortions rather than genuine pressures. Overall then while the labour market situation does look particularly uncertain right now , next week’s report seems unlikely to be much help in clarifying just w hat is going on.

POWELL LIKELY TO STICK TO HIS RECENT SCRIPT

Markets will be hoping that Fed Chair Powell’s semi-annual testimony on monetary policy to Congressional Committees on Wednesday and Thursday provides more information on the Fed’s policy intentions and in particular w hen ‘tapering ‘ of asset purchases may start. How ever, it is more likely that will happen at future Fed policy meetings. In the meantime, Powell’s remarks are likely to stick close to his comments following the Fed’s June policy meeting. That means that the inflation rise will still be described as ‘transitory’ but upside risks that require monitoring w ill be acknowledged. On the policy front, he will probably again say that the Fed is still some way from its goals and that the present very accommodative stance w ill only be eased very gradually with no concrete timetable being offered. Overall, that w ill give markets no fresh information on how policy will evolve.

ACTIVITY DATA TO PROVIDE UPDATES ON GROWTH TRENDS

A busy week for US activity indicators may give mixed messages on growth trends. June retail sales are expected to post a second consecutive monthly decline. How ever, the fall is forecast to be concentrated in car sales, which seem to be handicapped by stock availability issues due to supply chain problems. In contrast, industrial production is expected to post another sizeable rise in June despite the supply chain issues. In the Eurozone, already available data for some of the major economies point to a decline in industrial production in May. Supply chain issues which for example seem to cause particularly large problems for the German car industry have also been cited as factors here. Finally given concerns about slowing growth in China, Thursday’s updates for Q2 GDP and June retail sales and industrial production w ill be watched closely. GDP is likely to post a solid rise but timelier monthly data may provide the better gauge of the extent to which growth is slowing.

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