MARKET ANALYSIS | 05/11/2021
Dovish Fed taper announcement drives strong gains
Stocks posted impressive weekly gains as a relatively dovish Federal Reserve policy meeting, healthy economic data, and a strong tail end to the earnings season all boosted sentiment toward equities. The Dow Jones Industrial Average, the S&P 500 Index, and the Nasdaq Composite all reached record highs. Technology stocks and small caps were particularly strong, and growth shares outperformed value stocks. Oil prices dropped from their recent highs after Biden administration officials mentioned the possibility of releasing supply from the strategic petroleum reserve, hurting energy sector stocks.
The quarterly earnings season wound down with ongoing strong results as profit margins held up well despite higher commodity prices and supply chain disruptions in various industries. However, equity investors seemed to punish the companies with earnings that lagged consensus expectations more than they rewarded those that beat expectations.
Fed announces taper but alleviates fears about abrupt tightening
At Wednesday’s conclusion of the Federal Reserve’s policy meeting, the central bank stated that it will begin to slow its monthly bond purchases by USD 15 billion later this month and in December. By not specifying the speed of the taper beyond December, the widely expected tapering announcement gives the Fed the flexibility to make adjustments as economic conditions evolve.
The policy statement released after the meeting and Fed Chairman Jerome Powell’s post-meeting press conference stressed that policymakers still expect the recent high inflation readings to moderate and will need to see further labor market improvement before raising rates, helping to alleviate fears about an abrupt monetary policy tightening. This seemed to put a dovish spin on the tapering announcement for stock investors, who drove equities higher following the Fed meeting.
Robust economic data
Economic data released during the week were generally robust, showing that the economy gained strength as the late-summer wave of the delta variant eased. Factory orders increased 0.2% in September, slightly more than consensus expectations. The government’s October employment report, released on Friday morning, showed 531,000 jobs added, topping consensus estimates. The unemployment rate fell to 4.6%. The Labor Department also said that the economy gained 235,000 more jobs in August and September than it originally estimated.
Treasuries benefit from dovish Fed
U.S. Treasury yields decreased amid the Fed’s signals that it will take a patient approach toward monetary policy tightening, leading to gains. (Bond prices and yields move in opposite directions.) Municipal bonds modestly outperformed Treasuries, supported by a relatively light new issuance calendar.
According to our investment-grade corporate bond traders, credit spreads (additional yield relative to similar-maturity Treasuries) widened early in the week amid busy new supply and weak demand from buyers in Asia. The Fed meeting boosted sentiment toward investment-grade corporates, leading to spread tightening later in the week. A similar dynamic played out in the high yield bond market, where the firm’s traders noted that the well-telegraphed tapering announcement from the central bank prompted investors to add risk in high yield.
Shares in Europe rose on strong corporate earnings results and signals from the European Central Bank (ECB) that interest rates would stay low for some time. In local currency terms, the pan-European STOXX Europe 600 Index ended 1.67% higher. Germany’s Xetra DAX Index gained 2.33%, France’s CAC 40 Index rallied 3.08%, and Italy’s FTSE MIB Index climbed 3.42%. The UK’s FTSE 100 Index advanced 1.25%, as the UK pound weakened against the U.S. dollar after the Bank of England (BoE) unexpectedly kept interest rates unchanged. UK stocks tend to gain when the pound falls because many companies that are part of the index are multinationals with overseas revenues.
Core eurozone bond yields slipped from earlier highs after ECB President Christine Lagarde pushed back against raising interest rates in 2022, citing the bank’s expectations that inflation would remain “subdued” over the medium term. Core yields fell further after the BoE stood pat on rates. Peripheral eurozone bond yields and UK gilt yields also fell.
The European region is now the “epicenter” of the global novel coronavirus pandemic and could see another 500,000 deaths by February, Hans Kluge, the head of the World Health Organization’s Europe region warned. He blamed low vaccination rates in the Baltics, Balkans, and Central and Eastern Europe and the relaxation of social and public health measures for a surge in infections and deaths.
ECB’s Lagarde says rate hike “very unlikely” in 2022
Lagarde hardened her message on the central bank’s policy stance at an event in Lisbon, saying an interest rate hike is “very unlikely” next year and that financing conditions must remain favorable. “In our forward guidance on interest rates, we have clearly articulated the three conditions that need to be satisfied before rates will start to rise,” she said. “Despite the current inflation surge, the outlook for inflation over the medium term remains subdued, and thus these three conditions are very unlikely to be satisfied next year.”
German, French industrial output falls unexpectedly
French and German industrial production fell unexpectedly in September, as supply chain bottlenecks caused shortages. In Germany, production declined 1.1% sequentially, after dropping 3.5% in August. Output in France slipped 1.3% month over month.
Portugal to hold snap election at end of January
Portuguese President Marcelo Rebelo de Sousa’s dissolved parliament after lawmakers rejected the 2022 budget bill of the minority Socialist government and called a snap election for January 30. The Socialists, supported by the Communists and the Left Bloc, have been in power since 2015.
Japanese equities were buoyed over the week by the convincing election victory of Prime Minister Fumio Kishida’s ruling Liberal Democratic Party (LDP), with the Nikkei 225 rising 2.49% and the broader TOPIX Index gaining 2.01%. Investors were encouraged by the prospects of stable government and policy continuity. Against this backdrop, the yield on the 10-year Japanese government bond fell to 0.07% from 0.09% the prior week, while the yen finished the week at around JPY 113.8 against the U.S. dollar, continuing to hover near three-year lows as the Bank of Japan (BoJ) reaffirmed its commitment to maintaining easy monetary policies.
PM Kishida’s LDP fares better than expected in general election, retains majority
Japan’s ruling LDP, led by Prime Minister Kishida, fared better than expected in the October 31 general election, retaining majority control in the powerful lower house of parliament despite losing a sizable number of seats. With some polls having suggested that the LDP could lose its majority, Japanese equities rose on greater prospects for a stable government. Investors’ focus now turns to the large-scale stimulus package that Kishida has promised to draw up—by mid-November according to the Kyodo news agency—which is likely to comprise financial aid for businesses and people hit hard by the coronavirus pandemic and be funded by an extra budget the government aims to pass within the year. The economic package will also include cash handouts to minors.
While few details about Kishida’s prospective economic policies have been shared, at the COP26 climate summit, the prime minister signaled continuity in environmental policy, as well as announcing additional measures aimed at curbing global warming. Kishida reaffirmed Japan’s goal to achieve carbon neutrality by 2050 and to cut greenhouse gas emissions by 46% by 2030. He also promised up to USD 10 billion over five years in additional finance to assist Asia on the path to zero carbon emissions on top of an existing USD 60 billion announced in June by his predecessor Yoshihide Suga.
BoJ will not follow U.S. central bank in dialing back easing, according to Kuroda
The BoJ will not follow the U.S. Federal Reserve in dialing back easing, given Japan’s different circumstances, according to the central bank’s governor, Haruhiko Kuroda. Notably, price momentum in Japan is much weaker than in other countries; the BoJ recently slashed its forecast for the consumer price index (CPI), a measure of inflation, to 0% in fiscal year 2021. Kuroda reaffirmed the central bank’s commitment to achieving its 2% inflation target and also said that the BoJ will continue its yield curve control policy, which essentially entails keeping Japan’s 10-year government bond yield near zero—even after coronavirus infections are contained.
On the economic data front, Japan’s household spending fell in September amid consumers’ continued caution due to the coronavirus pandemic. Spending fell 1.9% year on year, following a 3.0% decrease in August. The data added to concerns that Japan’s economy contracted in the third quarter. News that Japan was set to ease its strict coronavirus-related entry rules—by letting foreigners visit the country for short business trips, study abroad, and technical training—was welcomed by investors.
Chinese markets recorded a weekly loss. The CSI 300 Index slipped 1.4% and the Shanghai Composite Index retreated 1.6% as headlines about the beleaguered property sector and a growing COVID-19 outbreak across the country dampened sentiment. Renewed restrictions in many places raised worries about supply chain constraints dampening the country’s growth outlook as infections spiked near a three-month high. Reflecting the flight to safety, the yield on the 10-year Chinese government bond fell 8 basis points to 2.908% from the previous week’s 2.989%, while the yuan rose 0.16% to 6.3995 against the U.S. dollar.
Kaisa Group Holdings became the latest developer in China’s USD 5 trillion property sector to reveal that it was having debt problems. The Shenzhen-based company, which has the most offshore debt coming due over the next year in the sector after China Evergrande Group, reportedly put 18 property projects valued at USD 12.8 billion on the auction block. The Kaisa asset sale plan follows a missed payment on a wealth management product and USD 11 billion of dollar bonds from the company, which guaranteed the wealth management product and said it was facing unprecedented liquidity pressure.
China’s property sector is grappling with a deepening liquidity crisis reflected in a wave of offshore debt defaults, credit rating downgrades, and selling in the stocks and bonds of major developers. Seven of the top 10 China-listed developers by revenue recorded steep declines in profitability in the July-to-September quarter, which has increased pressure on Beijing to support the stressed sector. Earlier in the week, Premier Li Keqiang was quoted in state media warning of downward pressure in the economy, though Li said that policymakers would keep economic operations within a reasonable range and take measures to support industrial sectors.
On the economic front, China’s official manufacturing Purchasing Managers’ Index fell to a worse-than-expected 49.2 in October from 49.6 in September, below the 50-point mark separating growth from contraction. October marked the second month that factory activity contracted and was the latest sign that the economy was losing steam after a strong recovery from the pandemic. In addition to slowing industrial growth, the troubled property sector, and tepid consumption, China is also grappling with a worsening power crunch. Last week, miners in the coal-producing provinces of Shanxi, Shaanxi, and Inner Mongolia pledged to cut prices after Beijing intervened in the sector to alleviate the energy crisis.
OTHER KEY MARKETS
Higher inflation in Russia
Russian stocks, as measured by the Russian Trading System (RTS) Index, returned about -1.7% for the five-day period ended Friday. The market was closed for a holiday on Thursday. On Wednesday, the government reported that inflation in October was 1.1% month over month and 8.1% year over year. The 12-month inflation rate was not only stronger than expected, but it was also higher than the 7.4% year-over-year inflation rate in September. According to T. Rowe Price sovereign analyst Peter Botoucharov, the Russian central bank has been pursuing an inflation-targeting monetary policy based on having positive real (inflation-adjusted) interest rates. As a result, many analysts expect the central bank to raise interest rates again when policymakers meet in mid-December. The most recent central bank action was to raise the key interest rate from 6.75% to 7.50% in the latter part of October. However, Botoucharov believes that inflation could be peaking around current levels in light of a stabilizing core consumer price index (which excludes food and energy costs), as well as leading economic indicators pointing to an easing of price pressures.
Turkish stocks gain
Turkish stocks, as measured by the BIST-100 Index, returned about 4.0%. During the week, the Turkish Statistical Institute (Turkstat) reported that month-over-month consumer price index (CPI) inflation in October was 2.3%, while year-over-year inflation was 19.9%. T. Rowe Price sovereign analyst Peter Botoucharov believes that the annualized CPI may be at or near a cyclical peak and could start to decline over the next month or two—assuming that a significantly weaker Turkish lira does not lead to additional import price increases. As inflation retreats from peak levels, many analysts expect additional interest rate reductions from the central bank. The central bank’s most recent rate cut brought the one-week repo auction rate down from 18.0% to 16.0% in October.