MARKET ANALYSIS | 17/09/2021
Stocks end lower as investors weigh conflicting signals
The small-cap Russell 2000 Index managed a small gain, but most of the major equity indexes ended the week modestly lower, as investors weighed some encouraging economic data against worries about supply chain challenges, elevated valuations, and concerns over how stocks would respond to an eventual tightening in monetary policy. Energy shares within the S&P 500 Index recorded solid gains on the back of rising oil prices, while strength in auto-related shares boosted consumer discretionary stocks. The small materials and utilities sectors lagged. T. Rowe Price traders observed that trading volumes were subdued for much of the week but were expected to pick up on Friday with the expiration of options and futures contracts.
The week began on a down note, which our traders attributed in part to moderating stimulus hopes. On Sunday, Democratic Senator Joe Manchin said he would support an infrastructure spending package of around USD 1.5 trillion, far less than USD 3.5 trillion that the more progressive members of Congress have proposed. Manchin, whose vote will be crucial for the bill’s passage, also stated that he believes congressional leaders should take their time as opposed to forcing the issue. To help fund the new package, Democrats are seeking to raise the corporate tax rate to 26.5%, up from the current 21%, while also raising the top capital gains tax rate from 20% to 25%—smaller increases than previously sought.
Inflation moderates even as retail sales rebound
Investors pondered a few significant data surprises during the week. On Tuesday, the Labor Department reported that core (less food and energy) consumer prices increased 0.1% in August, below consensus expectations for a 0.3% increase and the smallest gain since February. Declines in airfares and used car prices drove much of the shortfall. On Thursday, the Commerce Department reported that August retail sales outside the volatile auto sector jumped 1.8%, defying consensus expectations for a small decline. A gauge of factory activity in the New York region, reported Wednesday, also came in well above expectations.
Tuesday’s mild inflation data appeared to drive a rally in the bond market, helping push the yield on the benchmark 10-year U.S. Treasury note to its lowest intraday level since August 23, but the major equity benchmarks moved lower. (Bond prices and yields move in opposite directions.) T. Rowe Price traders observed that many investors seemed to believe that the benign inflation report was not likely to have implications for Federal Reserve policy given the outsized importance of the labor market recovery. Fed policymakers were scheduled to meet the following week, and many observers expected them to announce the first steps in tapering monthly asset purchases designed to hold down long-term interest rates.
Bond yields increase as investors await Fed meeting
While the softer-than-expected inflation data appeared to ease investors’ worries of expedited interest rate hikes, our fixed income traders reported that the solid manufacturing and retail sales data, along with technical trading factors, contributed to higher yields as the week progressed. Meanwhile, T. Rowe Price municipal traders observed some patience from buyers amid expectations for higher levels of issuance through the end of October. Nonetheless, the week’s primary Muni market deals, including California’s issuance of USD 2 billion in general obligation bonds, were met with solid overall demand.
According to our traders, primary issuance within the investment-grade corporate bond market exceeded Wall Street’s expectations for the week. Healthy trading volumes and overnight demand from Asia provided support from a technical perspective, but macroeconomic sentiment was mixed. While Tuesday’s data seemed to support Fed Chair Jerome Powell’s assertion that spiking inflation is transitory, concerns surrounding corporate tax increases and the impending deadline to raise the U.S. federal debt ceiling were noted. Conversely, after a busy start to the week, new high yield issuance moderated.
Shares in Europe weakened as concerns about the impact of the coronavirus’s delta variant on the global economy outweighed expectations of continuing central bank support. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 0.97% lower. Major indexes were mixed. Italy’s FTSE MIB Index ended modestly higher, but Germany’s Xetra DAX Index slipped 0.77%, and France’s CAC 40 Index lost 1.40%. The UK’s FTSE 100 Index slid 0.93%.
Core eurozone bond yields rose in sympathy with U.S. Treasuries, with a Financial Times report saying that the European Central Bank (ECB) expects to meet its 2% inflation target by 2025 and is on course to raise interest rates in about two years—significantly ahead of consensus expectations. Peripheral eurozone bonds tracked core yields. UK gilt yields advanced after data indicated that inflation surged in August, sparking concerns that this development might prompt the Bank of England (BoE) to increase interest rates sooner than expected.
ECB’s Lane reportedly says inflation target may be met by 2025
ECB Chief Economist Philip Lane told German economists at a private meeting that the central bank expects to hit its 2% inflation target by 2025, the Financial Times reported. This view and the ECB’s new policy framework suggest that conditions for raising interest rates could be met by 2023, the newspaper said. An ECB spokesperson said that the report was inaccurate. Separately, at an online event, Lane said that he was confident of reaching the inflation target. “If you are persistent with a high level of monetary stimulus, you can get there,” he said. “We think the current set of [monetary policy] instruments is working.”
Record jump in UK inflation triggers BoE letter; payrolls surge
Inflation in the UK jumped to 3.2% in August, its highest level in more than nine years. The Office for National Statistics said that much of the spike was due to a substantial drop in restaurant and café prices last year and meaningful increases this year. Because the inflation rate came in well above the BoE’s target, Governor Andrew Bailey must write a letter to the finance minister explaining how the central bank plans to bring it back in line.
Meanwhile, UK company payrolls rose by a record 241,000 in August, while the unemployment rate fell to 4.6% in the three months ended July 31. Retail sales unexpectedly fell for a fourth month in August, contracting 0.9% versus July. Economists had forecast growth of 0.5%.
Italy to fine unvaccinated workers; UK unveils COVID-19 winter plan
The Italian Cabinet ruled that the country’s 23 million public and private sector employees must show a “Green Pass”—providing proof of vaccination, a negative test, or recent recovery from infection—from October 15 to avoid sanctions that include fines of up to EUR 1,500 and suspension from work.
UK Prime Minister Boris Johnson unveiled a plan to prevent the National Health Service (NHS) from being overwhelmed by the coronavirus in winter, starting with vaccines for children 12 to 15 years old and booster jabs for those 50 years and older by Christmas. However, if the NHS comes under “unsustainable pressure,” vaccine passports could be imposed for mass events and face masks would become mandatory.
Japan’s stock markets rose over the week, with the Nikkei 225 Index up 0.39% and the broader TOPIX Index returning 0.41%. Campaigning began in the race to become the next president of the ruling Liberal Democratic Party (LDP) and thereby succeed Yoshihide Suga as prime minister. On the pandemic front, the country’s top coronavirus adviser, Shigeru Omi, said that the peak of the fifth COVID-19 wave has largely passed. He warned, however, that a close eye must still be kept on the country’s overburdened medical system. The government is aiming to ease the scope of coronavirus restrictions in November, once most of the population has been vaccinated. Against this backdrop, the yield on the 10-year Japanese government bond ticked up to 0.05%, while the yen hovered around JPY 109.9 against the U.S. dollar, little changed from the prior week.
Candidates begin campaigning in ruling LDP leadership race
Campaigning began for the next president of Japan’s ruling LDP, who is set to replace Prime Minister Suga, given the party’s majority in the powerful lower chamber of parliament. Ahead of the election on September 29, four lawmakers declared their candidacy by the deadline to do so: former Foreign Minister Fumio Kishida; Sanae Takaichi, who served in several cabinet posts under Shinzo Abe; Taro Kono, currently in charge of Japan’s COVID-19 vaccine rollout; and former Communications Minister Seiko Noda. Noda was the last to declare her candidacy and signaled a policy focus on social and welfare issues, as well as on boosting diversity and equal rights.
According to a poll by Bloomberg, a strong majority of economists expect Taro Kono to win the vote. His policies suggest that more stimulus and continuity in central bank policy would be in the cards under his leadership. Kono recently said that, to achieve national emissions targets, nuclear plants would have to be restarted in the short to medium term—this marks a divergence from his earlier stance against reactivation. He has also said that renewables and energy-saving installments will be the primary means for Japan to meet its net-zero carbon emissions target by 2050.
Manufacturers’ confidence falls as carmakers suffer from chip shortage; export growth slows
Confidence levels among Japanese manufacturers fell to a five-month low in September, with the Reuters Tankan Index falling to 18 from 33 in August (the index readings are derived by subtracting the percentage of respondents who say conditions are poor from those who say they are good). Weakness was attributable to the latest coronavirus wave, with activities and broader demand impeded by the health crisis, while carmakers reported the deepening impact of a global chip shortage. Some manufacturers have also had to contend with higher raw material prices.
Separate data showed that Japan’s exports rose 26.2% year on year in August, less than expected and following a 37.0% gain in the previous month. The spread of the highly contagious delta variant of the coronavirus in Asia and supply chain blockages impeding auto shipments both constrained export growth. While shipments of cars fell, exports of iron and steel, chipmaking equipment, and auto parts led gains over the month.
Stocks fell sharply for the week. Weak August economic data, a fresh coronavirus outbreak in Fujian province, the growing debt crisis at embattled property developer China Evergrande Group, and the threat of tighter gaming regulations in Macau dampened investor sentiment. The CSI 300 index of large-cap stocks fell 3.1%, and the Shanghai Composite Index retreated 2.4%, according to Reuters. Next week, China’s stock markets are closed Monday and Tuesday for the Mid-Autumn Festival and will reopen on Wednesday, September 22.
Yields on China’s government bonds were broadly flat for the week. In currency trading, the renminbi (RMB) weakened by 0.2% against the U.S. dollar. The RMB has largely moved with the dollar in recent weeks, with the trade-weighted currency index close to a five-year high. Foreign investor inflows into Chinese bonds have slowed in recent months, but analysts expect demand will increase after Chinese government bonds are included in the FTSE World Government Bond Index starting in October.
In corporate news, worsening debt problems at Evergrande, China’s third-largest developer, dominated headlines as concerns grew about a potential debt restructuring of the company, whose debt load exceeds USD 300 billion. During the week, China’s Ministry of Housing and Urban Rural Development told banks that Evergrande wouldn’t be able to make its interest payments due on September 20, Bloomberg reported, citing unnamed sources.
The inability to repay bank interest is the latest sign of a liquidity crisis at Evergrande, which is emerging as a key test of the Chinese government’s willingness to bail out systemically important, highly indebted companies. T. Rowe Price’s Asia-based fixed income analysts suspect that China’s government will likely focus on the social fallout of Evergrande’s unfinished housing units, followed by supply chain companies that are owed money by Evergrande.
On the economic front, China’s August indicators were surprisingly weak, underscoring the impact from continued coronavirus outbreaks across the mainland. Industrial output, retail sales, and fixed asset investment all missed expectations, particularly retail sales, which recorded its slowest growth pace since August 2020, according to Reuters. Economists had forecast a rebound in economic activity in September after an outbreak in August was quickly brought under control, but a recent coronavirus flare-up in Fujian could cause consumers to retrench once more. China’s zero-tolerance coronavirus policy has proven successful to date, though the short-term economic costs are high given the difficulty for consumer services and retail sales to recover under the threat of more restrictions.
OTHER KEY MARKETS
The Peruvian central bank has been in the news recently. Late in the previous week, monetary policy officials held their regularly scheduled meeting and raised the key interest rate by 50 basis points, from 0.50% to 1.00%, which was in line with expectations. T. Rowe Price emerging markets sovereign analyst Aaron Gifford said that the post-meeting statement was mixed. On one hand, the central bank removed or modified some language that suggested it would remain accommodative. On the other hand, it said that “the current decision does not necessarily imply a cycle of sequential hikes of the reference interest rate.”
Gifford noted that policymakers believe above-target inflation will be transitory and will return to the 1% to 3% target range over the next 12 months. This is despite inflation expectations that have been rising over the last few months. In terms of economic growth, the statement highlights those expectations deteriorated in August and remain in pessimistic territory. Also, while the economy is recovering, policymakers believe the output gap will remain negative.
Earlier in the week, newly elected President Pedro Castillo reportedly met for 90 minutes with current central bank governor Julio Velarde. There are reports that Velarde has agreed to stay in his position, though no official announcements have been made. In addition to the governor, who is appointed by the president but ratified by Congress, there are six other central bank board members: Three are designated by the president, and three are nominated by the unicameral legislature.
Chilean stocks, as measured by the S&P IPSA Index, were little changed through the close of business on Thursday. The stock market was closed for a holiday on Friday. During the week, the central bank published the minutes to its August 31 monetary policy meeting, at which policymakers unanimously hiked the key interest rate by 75 basis points. The rate increase was larger than many expected.
Gifford observes that the bulk of the document wasn’t too different from what was expressed in the post-meeting statement and the quarterly inflation report released a day later, but he did note a couple of interesting passages, particularly related to the size and speed of monetary tightening that the board is considering. Given Chile’s positive output gap, above-target inflation, rising inflation expectations, and idiosyncratic risks, the board found it necessary to raise the key rate by 75 basis points despite some policymakers’ fear of surprising markets.
However, they ultimately saw that this decision was “totally consistent” with the new scenario, which featured more fiscal stimulus and another piece of pension withdrawal legislation despite the already rapid recovery. Furthermore, they saw that it was “necessary to implement a rapid adjustment of the monetary impulse that would bring the policy rate close to its neutral value by the middle of the first half of 2022.” In the most recent quarterly inflation report, policymakers considered 3.5% to be the neutral rate—neither stimulative nor restrictive.