Europe’s vaccine programme begins to catch up with the UK and US
It’s been another good week in the financial markets – all the major equity markets rallied, and most bond markets made gains too. Indeed, the impetus for the equity rally was in large part the rally in bonds, as soothing words from central bankers made investors realise that official rates would stay low for a long time.
Inflation ticking up
As far as the US is concerned, the rally in yields reflected a fall in real rates – breakeven inflation stayed well above 2%. And that makes sense. We’re in for a period of rising inflation – and it’s not just base effects. Last week saw the release of the CPI figures for March. And the core number came in at 0.3% month-on-month, a shade higher than the consensus expectation if 0.2%. But the unrounded increase was 0.34%, just a smidgeon short of coming in at 0.4% in the rounded way that the number is reported. And we expect further strong increases in the months to come as a surge in spending leads to bottlenecks and higher prices. Whether that is sustained or not is the big question.
Investors are expecting to be surprised!
We are also in the midst of the corporate reporting season, with S&P500 companies leading the way. Last week saw financials dominate and they delivered very strong numbers. In the run up to this reporting season, analysts had been revising their numbers higher – the opposite of the normal pattern. So, this strong beat is even more impressive. Except that investors weren’t especially impressed. After three successive blow-out quarters where companies beat (admittedly heavily revised down) estimates, investors are complacent: expecting to be surprised – if that doesn’t sound like an oxymoron!
Economic momentum in developed markets is strong
And earnings are growing convincingly. The key driver in the US is of course their highly successful vaccine roll-out. Restrictions have been eased and new cases are now edging higher, but the extent of vaccination means that this isn’t translating into increased hospitalisations and fatalities, at least not in aggregate.
Over in Europe, it’s been a very different story, with much slower vaccine roll-outs and tighter lockdown restrictions. Expectations for growth in the eurozone this year have been slashed. But that is changing. The rate of vaccination has picked up strongly – almost to the UK level and will improve further. The news flow in Europe has turned and markets will anticipate a much better second half of the year for the eurozone economy.
The developed world appears on top of the virus; a very different story for EM
Yes, there are fears of new variants but overall the pandemic seems to be in retreat. It is a very different story in emerging markets. New cases are rising rapidly in countries like India and Brazil. So large is this increase, that it’s leading to record numbers at the global level even as developed nations see a decline.
A consumer boom for the UK; optimism peaking for the US
Back in the UK, the warm weather is coinciding with further easing of lockdown restrictions. We’re in for a consumer boom over the next few months – and I don’t think that is fully factored into the markets. That should be good news for sterling and could push gilt yields higher. Stronger sterling would be a headwind for the FTSE 100 as the majority of earnings are in dollars but domestic companies should do well.
So, while I do think US optimism may be peaking, and emerging markets face big challenges, the global recovery is gathering pace. It’s hard to see really strong gains from here, but risk assets do look set to continue to outperform.