Let The Good Times Roll

ANOTHER WEEK OF GOOD ECONOMIC DATA

Markets have been volatile this week making it difficult to gauge underlying trends. Most equity markets seem set to end the w eek down as concerns about a further w ave of Covid-19 infections predominate over hopes of an economic rebound. Government bond markets, most notably the UK and US, have seen a further fall in yields from their early April highs, although that still leaves them significantly up on the year. In currency markets, the US dollar remains under pressure. It did get a near-term lift against the euro on Thursday after European Central Bank chief Lagarde said there had been no discussion of slowing bond purchases at the ECB’s latest policy meeting. How ever, the euro quickly rebounded and w as given a further lift on Friday by better-than-expected Eurozone PMI data. This w eek’s data calendar provided further evidence that economies are poised for rapid rebounds as lockdown restrictions are eased. In the UK, retail sales in March rose at their fastest pace in 9 months.

Online sales helped retailers to shrug off a weak start to the year even before April’s re-opening of non-essential shops. Meanwhile, UK April PMIs pointed to a strong start to Q2 as both manufacturing and services activity accelerated. Elsewhere, the data calendar w as sparse but most notable w as the stronger-than-expected April Eurozone PMIs, which show ed the first rise in services output in the region since last August. They belied the recent tightening in restrictions in some parts of the region and supported ECB hopes of a Q2 pickup. Market uncertainty in the face of this good news may reflect concerns that the recovery could still peter out just as it did last autumn. The most likely cause of that would be further bad new s on Covid-19, which is why the data on new cases and the vaccine rollout will continue to be watched closely.

Another key issue for markets is when will monetary policy become less accommodating. So far, central banks have been making reassuring noises that this w ill not happen anytime soon. This week’s update by the ECB was again largely dovish. Next week will be the turn of the US Federal Reserve and the Bank of Japan and both seem certain to signal that policy will remain unchanged. However, less positive signs from this week’s PMIs were ongoing price pressures arising from rising commodity prices and supply chain disruptions. Central banks are dismissing such concerns as temporary but if they persist against a background of stronger growth, they could yet see a change in rhetoric on monetary policy later this year.

CONTRASTING TRENDS IN EARLY 2021

The coming w eek’s busier economic data calendar w ill highlight the contrasting trends in the US and the Eurozone in early 2021. In the US, GDP figures (Thu) are expected to show that the economy grew and at an accelerated rate in Q1 (w e look for a 7.5% annualised rise). That reflects less onerous restrictions than in the Eurozone or the UK and support from expansive monetary policy including substantial new fiscal stimulus. Monthly consumer spending (Fri) for March is likely to show strong spending at the end of the quarter, supported by the Biden fiscal package. With more support from this expected in the coming months, alongside a further easing in restrictions, w e foresee a further acceleration in Q2 GDP. In contrast, Q1 GDP in the Eurozone (Fri) is forecast to have fallen by 0.8% with the decline primarily centred in those areas of the service sector most directly impacted by restrictions. That would be the second consecutive quarterly fall, meaning that the economy w as in recession for the second time in 12 months. More positively, the April PMIs suggest that GDP w ill rise in Q2 despite ongoing restrictions and the relatively slow vaccine roll-out. The April German IFO survey is expected to provide further evidence of the improving situation. Also out next w eek is the April CPI report, w here inflation is forecast to rise to 1.6% from 1.3% in March. That is mostly due to higher energy prices while core inflation remains subdued. Next w eek’s UK calendar is very light. UK Q1 GDP is not out until 12th May. That is likely to decline due to January’s fall in output. However, we expect a further rise in GDP in March following February’s gain.

US FEDERAL RESERVE TO STAY DOVISH FOR NOW

Wednesday’s update from the Fed seems certain to leave monetary policy unchanged. The only real question is over whether the Fed will make any adjustments to its forward guidance given the increasingly positive new s on the economy. This is unlikely given that Fed policymakers have repeatedly said in recent weeks that policy needs to remain very supportive of the economy’s rebound. In particular, Fed Chair Powell has reiterated that it is too early to even start talking about ‘tapering’ asset purchases. Given that the Fed usually prefers to prepare markets for a policy move it would be a big surprise if recent comments have been the prelude to a change in direction. So we expect it to stick with a very dovish message for now . Nevertheless, recent developments do suggest that the Fed may soon start to prepare markets for a scaling down of asset buying from the end of 2021 and this may begin as soon as the next update in early June. Finally it should be noted that President Biden will testify to a joint session of Congress on Wednesday for the first time since his inauguration.

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