BlueBay AM: Fiscal squid

BlueBay AM: Fiscal squid

Monetary policy
Obligaties (02)

Just for laughs or is it money well spent?

By Mark Dowding, CIO at BlueBay Asset Management

A risk-off tone in the first couple of days in May saw equity markets and government bond yields trade somewhat lower, albeit in modest volumes and without much conviction. With little substantive ‘new’ news, the ‘sell in May and go away’ metaphor may have been partly responsible for this price action, following the recent run-up in stocks. 

However, we continue to sense markets trading in a sideways direction, awaiting a more convincing catalyst. In this context, the US labour market report later today could be a relevant data point. Incoming information appears to confirm that the US economy is experiencing a healthy expansion, with supply bottlenecks and shortages in some sectors being the main restraint on rampant demand. 

In the wake of this, we see growing evidence of pricing pressures and commodity prices continue to rise, with copper and lumber making notable gains. Lumber futures are up over 400% in the past year and 60% in the past month alone, in price action more closely resembling what is going on in cryptocurrency markets.

Over the coming month, we project core US CPI rising from 1.6% to 2.5%. Although part of this increase may be termed ‘transitory’, reflecting base effects from 2020, we are more doubtful that inflation will subsequently decline, as many commentators and the Federal Reserve currently predict. 

In our view, a modest rise in inflation expectations could see somewhat higher levels of price increases become more endemic in the months ahead. For the time being, our impression is that policymakers would be happy to cheer this on. 

Yellen this week appeared to acknowledge this and noted her expectation that this would see rates rise at some point. 

In some respects, this could be regarded as a communications blunder coming from the Treasury, when Yellen is very aware of the Fed’s need for operational independence (particularly after a Trump presidency when the Fed’s independence was being openly debated). 

Nevertheless, it can be viewed that Yellen is just laying the groundwork such that the nation and financial markets are prepared for rates to rise as the economy bounces back and returns to full employment in the months to come.

Europe

May Day celebrations made for a relatively quiet week in financial markets. 

In Spain, the victory of Diaz Ayuso for Partido Popular in Madrid elections saw politics shift to the right. In part, her calls for ‘freedom’ seem to resonate strongly with the populous. Her past insistence to keep bars in the Madrid region open, when socialist administrations had pushed for tighter lockdowns elsewhere, appears to have yielded dividends at the ballot box.

It is also interesting to reflect that, as countries emerge from the Covid nightmare and the associated totalitarian policies that have disrupted everyday life, so there may be a yearning for a more libertarian approach in the years ahead. 

UK elections

Regional elections in the UK saw the Labour Party under Keir Starmer struggle to make much headway against the Conservatives. 

Meanwhile, north of the border, nationalist parties appeared to fare well, but it seems likely that the SNP failed to achieve an outright majority. In recent weeks, polls have indicated waning support for Scottish independence. 

Although we expect the SNP to continue to agitate for this, we think it is unlikely that Westminster will give much ground in the foreseeable future on agreeing to a referendum. Had the SNP achieved a much stronger mandate, this could have been different, but it looks like this may be on the back burner for the time being.

Emerging markets

In EM, the focus has been back on Covid and risks related to economic fallout, with calls growing that India needs to enter a stricter national lockdown. With vaccination rates well below leading countries in developed markets (DM), it is understandable that Covid downside risks represent a bigger drag on EM growth relative to DM in 2021. 

Meanwhile, a spike in infections in Seychelles represents a concern for countries seeking to re-open their tourism sectors. In addition, the high level of vaccinations in the country (a world-leading 69% of total population), shows the risk posed by new variants and its experience would clearly be a worrying outcome were it to be repeated elsewhere on a larger scale.

At an index level, EM assets were slightly weaker in the first couple of days of May with local markets underperforming as the dollar moved a little firmer. Colombia was a notable underperformer, as the government bowed to populist demands opposed to measures to deliver fiscal consolidation and thus preserve the country’s investment-grade rating.

Overall, index moves were relatively contained. This was also the case in corporate credit, with spreads just a little wider as markets gear-up for a relatively heavy month of new issuance. 

Cryptos

It has been interesting to observe the recent ascent in the price of Dogecoin. With the ‘Doggy’ now at 69 cents, anyone in the US who invested their recent fiscal cheques into the coin would now have a holding in excess of USD500,000, such has been the boom in prices. 

Interestingly, this is occurring as momentum in Bitcoin seems to stall. Arguably, crypto is principally a channel for financial speculation and with Bitcoin becoming so large, it is now much more difficult to squeeze prices higher along an exponential path, meaning that those looking to get rich quick need to turn their attention to smaller units. 

If one were to write an article on the life cycle of a financial bubble, it appears that we are reaching an interesting moment when the best trade for the crypto crowd is now in finding the next ponzi-coin which they can bid to the moon.

Waiting for winds of change

As markets await a catalyst, a material surprise in the US labour market report could provide the impetus to shake markets from their recent torpor. However, a very substantial miss would probably be required to force any reassessment of the macro backdrop. 

For now, it is anticipated that jobs growth of close to one million workers per month can take unemployment down to end-2019 levels by early 2022.

We would not be surprised to see a more rapid normalisation, yet there does not seem a very active debate over the US economic outlook at the present time, as everyone tends to look for evidence of strong economic growth. The bigger question marks relate to how long this expansion can be sustained for, and of equal if not greater importance, what the outlook for inflation will be? 

We have previously articulated that waning secular downward pressure on prices is likely to coincide with a positive cyclical upswing in US inflation. Therefore, we expect policymakers to see the higher levels of inflation they are looking for in the months to come. 

It is possible that a single data print could lead markets to begin to discount this outcome and bring forward expectations of future policy tightening. This could see yields resuming a push higher in the next couple of months, with real yields also likely to move upwards in such a move. 

However, it is possible that an accumulation of data prints will be required in order for the ‘transitory’ inflation narrative to begin to weaken.

At the same time, we expect fiscal policy to keep on pushing an expansionary agenda. 

In the US, we certainly see plenty of benefit coming from a material upgrade to the country’s infrastructure and from investment in green technologies. Although some may raise concerns with respect to fiscal profligacy, it seems there is still a long way to go before government largesse gets truly out of hand. 

Conversely, in Japan some recent examples may appear more questionable. The town of Noto recently decided that it would be wise to spend its Covid fiscal-relief monies on a statue of a giant squid. Mind you, it could be argued that this seemingly bizarre decision has indeed managed to put the town firmly on the map. Moreover, it probably yields a bit more joy than the billions a country like the UK has spent on its now defunct ‘Track and Trace’ app!