Last week, the reflation trade continued to be the key theme driving asset markets: investors looked to vaccine rollouts allowing economies to reopen and the prospect of a further US1.9tn in fiscal stimulus in the US. This resulted in USTs coming under pressure with the yield on the UST 10-year and UST 30-year closing out the week 13bps higher at 1.34% and 2.14% respectively. The 2s30s spread widened 12bps to 202 bps. Global equity markets were mixed: after a strong start to the holiday shortened week, the S&P500 ended the week down 0.71% and the Nasdaq fell 1.57%. The trading week in a number of Asian markets was also shortened by the Lunar New Year holidays. The Nikkei fared better gaining 1.69% on the week taking the index above 30,000, a level it has not traded at since August 1990, spurred on with better than expected economic data releases: Q4 GDP expanded 12.7% (quarterly annualised).
Broadly, US economic data releases pointed to improvement: On Wednesday US retail sales for January was a blow out figure registering 5.3% mom when the survey had been looking for 1.1%. The January PPI data had also exceeded expectations registering 1.3% mom. Friday’s February PMI data was robust with the services composite coming in ahead of expectations at 58.9 versus expectations of 58 although the manufacturing PMI came in slightly below expectations at 58.5. The employment data was less positive: weekly US jobless claims increased to 861,000 and the prior week’s figure was revised up by 55,000 to 848,000. Nevertheless, midweek the FOMC minutes continued to highlight “the economy remained far from the Committee’s longer run goals” and that the outlook is uncertain, and the path of the virus would be critical in determining the path of the economy. On inflation “Participants generally viewed the risks to the outlook for inflation as having become more balanced than was the case over most of 2020, although most still viewed the risks as weighted to the downside.” Plus, “Many participants stressed the importance of distinguishing between such one-time changes in relative prices and changes in the underlying trend for inflation, noting that changes in relative prices could temporarily raise measured inflation but would be unlikely to have a lasting effect. Some participants further observed that 12-month PCE inflation was likely to move somewhat above 2 percent for a brief period in the spring as the unusually low monthly observations from last spring roll out of the 12-month calculation.”
The ECB minutes for January suggested policy will remain supportive noting “a temporary boost to inflation should not be mistaken for a sustained increase, which was still likely to emerge only slowly.” However, the reflation theme continued to be a focus for markets. In Germany, the manufacturing PMI for February reached a 3 year high of 60.6 but the services PMI was much weaker falling to a 9 month low of 45.9. The German ZEW survey of expectations for February came well ahead expectations. A combination of the stronger data and general reflation trade saw the bund curve steepen. In Italy Mario Draghi moved forward with his unity government’s agenda with aims to accelerate the vaccine rollout, invest the EUR210bn of EU recovery funds and implement structural reforms in the legal system and public administration. A 10 year BTP issue received strong demand of EUR65.5bn versus the issue size of EUR10bn and was priced at a yield of 0.604%. In the UK, January retail sales disappointed falling 5.9% yoy but the PMI data for February was better than expected. The market looked to the continued progress of the vaccine programme and the potential for the economy to reopen. The 10 year gilt yield rose 18bps to 0.70% at Friday’s close and sterling strengthened versus the US dollar.
In the week ahead, progress on the vaccine rollout and whether covid infections continue to fall remains a focus, On Monday Boris Johnson is due to announce the roadmap for bringing England out of lockdown while on Thursday EU leaders hold a video summit with travel restrictions and vaccines expected to be a topic of discussion. Progress on the US USD1.9tn stimulus package will also be a focus: Nancy Pelosi, D-Calif., stated she hoped for a full House vote on the package by the end of this week. Key speakers over the week include Jerome Powell who is due to present his semi-annual economic testimony before the Senate Banking Committee on Tuesday and the US House Committee on Financial Services on Wednesday. Lael Brainard, Richard Clarida, Randal Quarles, Raphael Bostic, James Bullard and John Williams are also due to speak later in the week. Other central bank speakers include ECB President Christine Lagarde on Monday, BoE MPC Member Gertjan Vlieghe on Tuesday and Andy Haldane the BoE Governor on Wednesday. In terms of central bank news, the PBoC is expected to leave its 1 year and 5 year loan prime rates unchanged at 3.85% and 4.65% and RBNZ is not expected to maintain its current policy settings at its meeting on Wednesday. Key US data releases include the Chicago Fed National Activity Index for January, the preliminary estimate for January durable goods orders, 4Q’20 GDP (second estimate) where the Bloomberg survey is looking for a 4.2% annualised rate of growth versus the initial estimate of 4%. US January new home sales and pending home sales for January is also due. Finally, on Friday the January PCE deflator will be closely watched given the focus on inflation with the Bloomberg survey looking for a gain of 1.4% yoy. In Europe, the German IFO survey data for February is due on Monday and will be watched as a gauge of how the economy is faring. On Tuesday, the final reading of the Euro area CPI is due with the Bloomberg survey looking for a reading of 0.9%.