MARKET ANALYSIS | 10/09/2021
Stocks pull back on growth and inflation worries
The major indexes retreated over the shortened trading week—markets were closed on Monday in observance of Labor Day. The small real estate sector led the declines in the S&P 500 Index as longer-term interest rates increased, while consumer staples and utilities stocks held up best. The small-cap Russell 2000 Index fared worst after two consecutive weeks of outperforming the large-cap benchmarks, and value stocks trailed growth shares. T. Rowe Price traders noted that, although volatility increased, trading volumes remained somewhat subdued, in part because of the week’s religious holidays.
Our traders pointed to several factors weighing on sentiment, including September’s reputation for being a weak month for stocks. The previous week’s significant August payrolls miss seemed to linger in the minds of investors and exacerbate worries that the delta variant of the coronavirus was slowing the economic rebound. On Thursday afternoon, President Joe Biden announced that all large employers must require workers to either be vaccinated or submit to weekly testing, while vaccination would be mandatory for federal workers and contractors. While evidence continued to emerge that the latest coronavirus wave was peaking, health officials warned that the return to school and Labor Day social gatherings might derail progress.
Biden’s stimulus plan faces new hurdles as federal debt ceiling looms
Political uncertainty may also have been at work. On Wednesday, the website Axios reported that Democratic Senator Joe Manchin backs as little as USD 1 trillion of Biden’s USD 3.5 trillion spending plan, highlighting the wide gap between moderates and progressives, although other sources indicated later in the week that Manchin might be willing to go as high as USD 2 trillion. Manchin’s vote will be critical in passing the legislation in the evenly divided U.S. Senate (with Vice President Kamala Harris able to break the deadlock). Meanwhile, Treasury Secretary Janet Yellen said that extraordinary measures to avoid breaking the congressionally mandated federal debt ceiling were likely to be exhausted in October and reiterated her plea for legislators to take action.
Finally, inflation worries may have continued to weigh on sentiment. On Friday, stocks appeared to slip after the Labor Department reported that producer prices rose 0.7% in August, a slowdown from July’s 1.0% gain, but above consensus expectations for a 0.6% increase. The tight labor market signaled further profit margin challenges for firms. According to the Job Openings and Labor Turnover Survey (JOLTS) data released Wednesday, there were a record 10.93 million positions waiting to be filled in July, almost 1 million more than consensus estimates. Weekly jobless claims also fell more than forecast to a new pandemic-era low of 310,000.
Producer price data send bond yields higher
The Friday morning’s producer price data appeared to reverse a downward trend in the yield on the benchmark 10-year U.S. Treasury note, leaving it modestly higher for the week. (Bond prices and yields move in opposite directions.) T. Rowe Price traders reported that rates were also pushed higher at the start of the trading week by heavy issuance of corporate bonds and shorter-maturity Treasury notes. The week’s 30-year U.S. Treasury bond auction also witnessed strong demand.
Trading activity was relatively quiet in the municipal bond market during the holiday-shortened week, according to our traders, and steady cash flows continued to reinforce low yield levels. They also indicated that demand for longer maturities in the secondary market was somewhat soft as investors appeared to be waiting for dealers to clear more inventory of long-term securities.
The high yield market was also fairly quiet, as concerns over economic growth and the Federal Reserve’s eventual tapering of its monthly asset purchases contributed to a weaker economic backdrop. Our high yield traders noted that the primary calendar was somewhat slow to accelerate following the Labor Day holiday, with new deal announcements expected to pick up steam the following week. Conversely, the investment-grade corporate bond primary calendar was active, with the number of new deals setting a daily record at the start of the short week. Despite a softer macroeconomic backdrop highlighted by weakness in U.S. equities, technical conditions were supported by healthy overnight demand from Asia, and the new issues were well subscribed.
Shares in Europe weakened amid uncertainty about the economic outlook, the continuing coronavirus pandemic, and central bank policy. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.19% lower. Major stock indexes also fell. Germany’s Xetra DAX Index eased 1.09%, Italy’s FTSE MIB Index slipped 1.45%, and France’s CAC 40 Index lost 0.39%. The UK’s FTSE 100 Index declined 1.53%.
Core eurozone bond yields ended slightly higher, paring earlier gains, after European Central Bank (ECB) President Christine Lagarde said the decision by the central bank to trim its emergency bond purchases was not tapering. Peripheral eurozone bond yields broadly followed yields in core markets. UK gilt yields rose amid growing expectations that the Bank of England (BoE) may start raising short-term interest rates.
ECB to trim pandemic bond purchases
The ECB said, after its latest policy meeting, that it had decided to move to a “moderately lower pace” of bond purchases under its Pandemic Emergency Purchases Program for the rest of the year, after a rebound in European growth and inflation. Lagarde said that the central bank was not tapering its stimulus. “What we have done today … unanimously, is to calibrate the pace of our purchases to deliver on our goal of favorable financing conditions. We have not discussed what comes next,” she said. Lagarde remained cautious on the economic outlook, saying, “We are not out of the woods.” The risks to the outlook are “broadly balanced” and “price pressures are building only slowly.”
The ECB also raised its forecast for 2021 economic growth to 5.0% from 4.6% and its inflation projection to 2.2% from 1.9%. The central bank’s projections showed inflation peaking at 3.1% in the fourth quarter and then slowing to 1.7% in 2022 and 1.5% in 2023.
UK raises taxes; BoE policymakers evenly split in August
UK Prime Minister Boris Johnson secured parliamentary approval for GBP 12 billion in tax increases to fund changes to social care and the National Health Service. Under the plan, some investors will face higher levies on dividends, while the national insurance contributions taken out of paychecks will also increase.
BoE Governor Andrew Bailey revealed at a parliamentary hearing that the policy committee was split 4–4 over whether to raise short-term rates from 0.1% in August. However, BoE officials also maintained that some modest tightening was likely over the forecast horizon. Separately, UK economic growth slowed in July to 0.1%—compared with 1.0% in June—as the spread of the coronavirus prompted millions of people to self-isolate.
EU plans to issue green bonds in October
The European Commission (EC) said it planned to launch green bonds in October to fund environmental projects as part of an effort that aims to raise up to EUR 250 billion through 2026. Eleven member states have already issued green bonds, while another four plan to do so.
Japanese equities extended their gains over the week, buoyed by political optimism and expectations of further fiscal stimulus under a new prime minister, following the decision by current Prime Minister Yoshihide Suga to step down. The Nikkei 225 Index returned 4.30% while the broader TOPIX Index rose 3.78%. While the government again extended its coronavirus state of emergency measures, sentiment was boosted by the announcement of plans to ease restrictions once most of the population has been vaccinated, with relaxation expected to commence around November. Against this backdrop, the yield on the 10-year Japanese government bond remained broadly unchanged from the end of the previous week at 0.04%, while the yen weakened to JPY 109.97 against the U.S. dollar (from 109.72 the prior week).
Liberal Democrat Party leadership candidates lay out their platforms
Following Prime Minister Suga’s surprise declaration that he would not seek reelection as leader of Japan’s ruling Liberal Democrat Party (LDP), three candidates in the contest to replace him started to lay out their platforms. Former Foreign Minister Fumio Kishida said that while the deregulation and structural reforms promoted by Suga and his predecessor, Shinzo Abe, undoubtedly yielded results, his focus would be on properly distributing the fruits of growth to prevent disparities from widening. He called for a massive stimulus package—of more than JPY 30 trillion (USD 270 billion), according to some reports—to cushion the blow from the coronavirus pandemic.
Meanwhile, Sanae Takaichi, who has served in several cabinet posts under Abe and is seeking to become Japan’s first female prime minister, pledged to stick to the Abenomics program of her predecessors, which relies on aggressive monetary and fiscal stimulus. Like Kishida, Takaichi said she would consider an extra budget to aid the economy but gave no indication about the size of the package.
The third lawmaker to declare his candidacy in the leadership election was Taro Kono, who has been in charge of Japan’s COVID-19 vaccine rollout and has led public opinion polls as the preferred candidate to succeed Suga. On the policy front, he has highlighted the importance of promoting digitalization and green technologies. He has also said that emergency spending couldn’t be avoided, while the amount and targets are yet to be decided.
BoJ governor says rates will stay low even if fiscal policy becomes more expansionary
With markets expecting further fiscal stimulus under a new prime minister, the Bank of Japan (BoJ) Governor Haruhiko Kuroda said, in an interview with Nikkei, that rates will remain low to enhance the effect of fiscal policy. He does not expect additional fiscal spending to have a negative impact on markets but added that the BoJ will monitor developments carefully. According to Kuroda, the BoJ will continue with current monetary easing (even after the coronavirus pandemic abates and until the 2% inflation target is reached) and stands ready to take additional easing measures as needed without hesitation.
Japan’s economy grew faster than initially estimated in the second quarter
Second-quarter gross domestic product growth was revised up to an annualized 1.9% from a preliminary reading of 1.3%. The main driver was an upward revision to government consumption, while both private non-residential investment and private consumption were subject to moderate upgrades. These were slightly offset by a larger-than-anticipated drag from private inventories.
Separate data showed that household spending grew by 0.7% year on year in July compared with expectations of a 2.4% rise, as a resurgence in COVID-19 cases hindered consumer activity. A positive contribution came largely from transportation, followed by a smaller degree of support from food and beverage. Most other categories dragged, led by furniture and household goods, as well as health care.
Chinese stocks rose for the third straight week. The Shanghai Composite Index gained 3.4% and the CSI 300 Index of large-cap stocks rallied 3.5%, according to Reuters. Strong trade data and an unexpected yet reportedly candid phone conversation between the U.S. and Chinese presidents lifted investor sentiment. The yield on China’s 10-year government bond increased and ended the week at 2.89%, while the renminbi currency edged up 0.2% versus the U.S. dollar to 6.4423 per dollar, its strongest level since mid-June, according to Bloomberg.
China’s merchandise exports in August increased 25.6% over a year earlier, while imports climbed 33.1%, according to the country’s statistics office. The trade data beat forecasts despite renewed lockdowns across the country following a recent outbreak of the delta coronavirus, which led to a two-week closure of a key container port in the southern city of Ningbo in August. China’s monthly trade surplus rose to USD 58.34 billion in August, up from July’s USD 56.58 billion.
Producer inflation outpaces consumer inflation
On the economic front, inflation data continued to show elevated producer prices and subdued consumer prices, which have been restrained by lower fuel and pork prices. The producer price index (PPI) rose 9.5% in August from a year ago mostly due to higher commodity prices that have been a major driver of factory gate inflation this year. August’s PPI reached a 13-year high, according to Bloomberg. The recent acceleration in China’s PPI is a growing concern for the government since the widening gap between producer and consumer prices could signal pressure on domestic manufacturers’ profit margins.
In other news, China plans to integrate Hong Kong’s economy more closely with the “Greater Bay Area,” a cluster of cities in Guangdong province’s Pearl River Delta that Beijing wants to transform into an economic powerhouse, the South China Morning Post reported. The latest development regarding the Greater Bay Area comes as China announced a major expansion of the Qianhai economic cooperation zone in the southeastern city of Shenzhen. Beijing is positioning the Qianhai economic zone, which was opened in 2009, as a testing area for reform and for further opening China’s financial sector, according to the Post.
OTHER KEY MARKETS
Turkish stocks, as measured by the BIST-100 Index, returned about -2.0%. Late last week, the government reported that the consumer price index (CPI) in August increased 1.1% month over month and 19.25% year over year. This was slightly above expectations. T. Rowe Price sovereign analyst Peter Botoucharov noted, however, that the core CPI, which excludes food and energy, slipped to 16.8% year over year in August from 17.2% in July. In response to the higher CPI, Turkey’s Treasury and Finance Ministry on Monday raised its year-end 2021 inflation estimate to 16.2%, which brings the government’s projection in line with market expectations of roughly 15.5% to 16.5% year-over-year inflation by the end of 2021. Some believe the central bank will follow suit and revise its own inflation estimate by considering higher food prices and industrial and supply chain disruptions.
On Wednesday, Central Bank Governor Sahap Kavcioglu claimed that “transitory” inflation pressures would dissipate soon and that inflation would decelerate in the fourth quarter. He also acknowledged that core inflation plays an important role in the central bank’s monetary policy decisions—comments that to some appeared to pave the way for fourth-quarter rate cuts.
At present, Botoucharov believes that headline CPI inflation will peak in September and turn lower in the fourth quarter to finish the year in the 15% to 16% range.
Stocks in Brazil, as measured by the Bovespa Index, returned about -2.1%.
Brazilian assets were under pressure due in part to political tensions—specifically between the Bolsonaro administration and the judiciary—and related street protests and demonstrations. Toward the end of the week, however, President Jair Bolsonaro took a somewhat conciliatory stance in a written statement in which he confirmed his “respect for the institutions of the Republic.”
Worse-than-expected inflation data for August were also a contributing factor. The government reported that inflation rose 0.87% month over month in August, with core prices, including services prices—which are closely watched by the central bank—surprising to the upside. While the inflation acceleration might have started out as price shocks involving food, fuel, and electricity, many believe there is clear evidence of second-order impacts on inflation.