After a first quarter in which equities and long-term rates rose in sync against the backdrop of a favourable economic outlook, financial markets have, in April, been largely directionless. What should we make of this?
The 4.8% increase in the MSCI All Country (AC) World equity index (in USD terms) from the end of March can be seen to reflect a strong start to the latest earnings reporting season and optimism among economic agents. Business and confidence surveys are providing indications that the nascent recovery will assert itself as mass vaccination allows for an eventual and gradual return to (a form of) normalcy.
However, global equities have been trendless in the last few weeks despite stronger-than-expected economic indicators and the message from government bond markets has not been clearer. After a worrying rise in the first quarter, the yield on the 10-year US T-note fell from nearly 1.75% at the end of March to 1.53% on 22 April and stood at 1.62% on 27 April. The yield on the German 10-year Bund hardly moved, but the Italian 10-year yield rose to above 0.80%, its highest since October.
At first glance, this underperformance of European bond markets is at odds with the current outlook: economic growth is expected to have accelerated strongly in the US, which should put upward pressure on yields, while eurozone growth is forecast to have contracted. At the same, the pandemic appears to be more and more under control in the US, while hospitalisations and infection rates have been static, if not rising, in the eurozone where vaccination is progressing more slowly.
Indeed, the news on the pandemic is disparate. Shocking images from India have led to the deployment of international aid to a country which is a major player in vaccine production. Delays in output resulting from the proliferation of the virus could crimp vaccination programmes in emerging countries that depend on Indian supplies.
In Europe, vaccination has accelerated in recent days, but the proportion of the population vaccinated is still modest: 20% has received at least one dose. In the US, where 40% of the population has at least had one shot, the pace is now slowing. This is largely due to supply problems.
A survey by Ipsos in 15 countries shows that vaccination intent has soared across the world. However, segments of populations remain reluctant: around 20% in the US and France. This may cause problems when ‘herd immunity’ is the goal.
From an investor point of view, vaccinations can still be expected to clear the way for a return to normality, even if the authorities occasionally pause the reopening of the economy to limit infections and congestion in hospitals.
The results of recent business and consumer confidence surveys can be said to justify the investor optimism. For the eurozone, the purchasing manager index, which reflects activity in manufacturing and services, stood at 51.7 in April, its highest in nine months. Indications on order books, employment and the 12-month outlook on activity were favourable.
In the UK, the reopening of the economy lifted the services sector: the PMI reached its highest in nearly seven years (see Exhibit 1). In Japan, the composite index managed to rise to slightly above 50 for its highest level since September 2019. Finally, in the US, the manufacturing and services indices are now well above 60, reaching record highs since the start of the series in October 2009.
This is good news, even if there were some surprises: in France, for example, the index exceeded expectations for manufacturing, but also in services where a decline had been expected after the latest tightening of restrictions. Instead, the index rose to 50.4 in April, signalling an expansion of activity. However, next month’s surveys could be harder to interpret and cause volatility on the markets.
Consumer confidence may be more in line with the outlook. The prospect of a return to normal daily life after well over a year of curbs has taken the US Conference Board index to its highest since February 2020. The eurozone measure is now firmly above its long-term average.
Confidence is also improving in the lowest income brackets. The effects of fiscal packages and employment protection plans are shining through here. Major European countries are about to present their plans to Brussels for their share of the multi-billion euro Next Generation EU fund. In the US, President Biden is due to present his ‘American Families Plan’ to Congress. Both should give households clearer clues of what help they can expect from fiscal policy.
The Bank of Canada has surprised with news that it would trim its weekly asset purchases from CAD 4 billion to CAD 3 billion as of 26 April, but we expect this example not to be followed quickly by other central banks with large-scale economic support packages.
Indeed, the European Central Bank has said that phasing out its Emergency Pandemic Purchasing Programme was not discussed at its latest policy meeting because it was premature. Given the recent comments by several policy council members, the 10 June meeting could, however, see a heated debate as some members seek a possible taper of asset purchases.
As in Frankfurt, the atmosphere should remain muted in Washington at the US Federal Reserve’s policy meeting. Signs of accelerating growth have multiplied since the previous meeting, but chair Jerome Powell has only said the economy is at an ‘inflection point’. Powell has regularly highlighted the new flexible average inflation-targeting framework which allows for a possible acceleration in inflation without the Fed having to take preventative action.
Supportive monetary and fiscal policies, progress towards herd immunity and the reopening of economies are leaving the medium-term scenario for risky assets intact. In the short term, the financial markets could see further erratic moves before they are convinced that economic growth allows equities to cope with moderately higher long-term yields and temporarily higher inflation.
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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