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Market Analysis 01/10/2021


Stocks pull back on inflation and interest rate fears A Friday rally moderated the losses, but the large-cap benchmarks and Nasdaq Composite index recorded their biggest weekly drops since February and rounded out the worst monthly declines since the onset of the pandemic, seemingly weighed down by inflation and interest rate fears. The S&P MidCap 400 and small-cap Russell 2000 indexes ended with only modest losses. Declines within the S&P 500 were broad-based, with only energy shares notching a gain. Growth stocks fared worse than value shares, which was mirrored in the underperformance of the technology-heavy Nasdaq Composite Index. Rising U.S. Treasury yields seemed to overhang sentiment throughout the week, with many investors appearing to view the Federal Reserve’s policy statement the previous week in an increasingly hawkish light. Following the meeting, policymakers announced a slight increase in their short-term interest rate expectations, as well as plans to consider tapering their monthly asset purchases. Price traders noted that Fed officials were scheduled to speak on a total of 19 different occasions during the week, helping to keep the spotlight on monetary policy. Debt ceiling and stimulus uncertainty also weigh The fiscal policy environment also appeared unsettling. The possibility that the federal government would experience another partial shutdown was averted late in the week when the Senate and the House of Representatives passed, and President Joe Biden signed, a short-term spending bill. No progress was made in raising the federal debt limit, however, and Treasury Secretary Janet Yellen warned again that the limit needed to be suspended or raised by October 18 in order for the Treasury to meet its obligations. While most observers agree that an actual default on the country’s debt is highly unlikely—especially given that Democrats may turn to tools to do it unilaterally—substantial market volatility followed previous episodes of brinkmanship a decade ago. Meanwhile, the outlook for the bipartisan, USD 1 trillion infrastructure bill also remained clouded. Democratic leaders abandoned plans for a vote on the bill on Thursday evening, following demands from progressives in the party to link its passage to a separate bill focusing on health care, education, climate measures, and other social policy priorities. Supply constraints feed inflation worries The week’s inflation data were arguably not alarming, with the Commerce Department’s core (less food and energy) personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, rising 3.6% over the 12 months ending in August, matching consensus. Continuing reports of supply restraints seemed to concern investors, however. Shares in Nike, Bed Bath & Beyond, and Kohl’s fell sharply, for example, after the companies reported stressed supply chains and higher labor costs ahead of the holiday shopping season. The recent surge in oil prices, which benefited energy stocks, also raised broader inflation worries. Inflation concerns seemed to be growing among consumers, as well. The gauges of consumer attitudes released during the week offered mixed messages, with the Conference Board’s indicator falling to a seven-month low in September, while the University of Michigan’s ticked higher. The lead Michigan researcher noted, however, that “consumers have become much more concerned about rising inflation and slower wage growth and their negative impact on their living standards.” Much of the rest of the week’s data were upbeat. Growth in durable goods orders for August exceeded expectations, and pending home sales jumped unexpectedly. Following a decline in July, personal spending bounced back more than expected (0.8% versus 0.6%) in August as consumers ramped up purchases for services, while The Wall Street Journal reported that some high-frequency data on spending at restaurants suggested that fears over the delta variant may be waning. Stock futures rose Thursday evening, following news that Merck and partner Ridgeback Biotherapeutics were seeking emergency use authorization for their new antiviral treatment for COVID-19, which appears to cut hospitalizations in half in unvaccinated individuals—momentum that may have carried over into Friday’s strong rally. The yield on the benchmark 10-year U.S. Treasury note spiked to a three-month high at midweek before falling back to end the week roughly where it started. (Bond prices and yields move in opposite directions.) As yields stabilized, our municipal traders observed improved buying activity—especially in long-term maturities and higher-yielding segments, such as airports and toll roads. Corporate issuance continues to see strong demand Our traders noted that investment-grade corporate bond spreads tightened initially as ongoing demand from Asia, the recent move higher in rates, manageable new issuance, and inflows to the asset class provided support. However, a slowdown in overnight demand as well as weakness in equities and the broader macroeconomic backdrop led spreads wider as the week progressed. Despite the drop in sentiment, new issuance was met with strong demand. High yield issuers initially remained active despite the macro backdrop, according to our traders, but the volume of new deals subsided as the week progressed. Negative headlines about energy prices, Chinese property developer Evergrande, and gridlock in Washington weighed on investor sentiment.


Shares in Europe fell sharply amid fears that the economy might be sliding into a period of low growth and high inflation. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 2.24% lower. Germany’s Xetra DAX Index tumbled 2.42%, France’s CAC 40 Index dropped 1.82%, Italy’s FTSE MIB Index lost 1.36%, and the UK’s FTSE 100 Index gave up 1.36%. Core eurozone bond yields rose amid a sell-off in global developed market bonds and as hawkish Federal Reserve comments raised expectations of imminent U.S. monetary policy tightening. German inflation also reached a 29-year high of 4.1%, which contributed to the uptick in core bond yields. Peripheral and UK government bonds largely tracked core markets. Strong inflation in eurozone, but ECB’s Lagarde says it’s temporary On a year-over-year basis, eurozone consumer prices jumped 3.4% in August—up from 3% a month earlier and the highest level since September 2008. A consensus estimate had called for a 3.3% increase in consumer prices. Higher energy costs were a big part of this upsurge. Core inflation, a metric that excludes volatile food and energy prices, accelerated to 1.9% from 1.6%. The price of durable goods rose on supply chain and production disruptions. European Central Bank (ECB) President Christine Lagarde acknowledged in testimony to the European Parliament that inflation in the eurozone could exceed the central bank’s forecasts, which have already been raised twice this year. “While inflation could prove weaker than foreseen if economic activity were to be affected by a renewed tightening of restrictions, there are some factors that could lead to stronger price pressures than are currently expected,” she said. However, the ECB president stuck to the official forecast that an increase in inflation would be temporary. Later, at the central bank’s annual forum, Lagarde said it was important not to overreact to transitory supply shocks that are boosting inflation in the eurozone. BoE’s Bailey says UK growth slower than expected Bank of England (BoE) Governor Andrew Bailey said that UK gross domestic product probably won’t recover to pre-pandemic levels until early next year—a few months later than previously predicted. He said the BoE will keep a “close watch” on inflation expectations and the labor market for signs that temporary price pressures are becoming more persistent. Germany faces months of coalition haggling The left-of-center Social Democratic Party (SPD), led by Olaf Scholz, won the German general election by only a small margin. The SPD and the center-right alliance of the Christian Democratic Union and Christian Social Union (CDU/CSU), in power for 16 years, are now expected to vie for the support of the Green Party and liberal Free Democrats to form a majority coalition government—likely a lengthy process. Angela Merkel will stay on as a caretaker chancellor.


Japanese stocks followed the lead of U.S. markets and declined during the week. The Nikkei 225 Index lost 4.89%, with losses concentrated on Wednesday and Friday, but remained in positive territory for the year-to-date period. The broader TOPIX Index also lost about 5% for the week. The Japanese yen weakened versus a strong U.S. dollar through Thursday but recovered somewhat on Friday; the yen traded around 111.20 against the greenback at the end of the week. Meanwhile, the yield of the 10-year Japanese government bond climbed slightly midweek before ending nearly unchanged at 0.055%. Little change expected as Kishida moves closer to becoming prime minister Former foreign minister Fumio Kishida won the Liberal Democratic Party’s (LDP) presidential election by beating Taro Kono in the leadership runoff. The victory gives Kishida a nearly certain path to succeed Yoshihide Suga as Japan’s prime minister as the LDP-led coalition has a majority in Parliament. According to T. Rowe Price international economist Aadish Kumar, Kishida’s impact on financial assets will be limited as government policy is expected to remain largely unchanged, particularly in the near term. Kumar noted that Kishida is seen as a consensus builder who will continue to push forward with the structural reform agenda introduced by Suga. In terms of fiscal policy, he has mentioned the need for additional support for the economy, although he has provided few details. Kishida’s views on monetary policy appear to be in line with those of Bank of Japan (BoJ) officials as he has noted the importance of avoiding deflation and keeping the 2% inflation target. Over the medium term, Kishida has also indicated a focus on narrowing the inequality gap in Japan through expanding welfare and helping low- and middle-income families. As political leadership changes, BoJ chief affirms stimulative monetary policy BoJ Governor Haruhiko Kuroda said a new prime minister will not cause the central bank to change its policies. Kuroda’s comments at an ECB conference came just a few days after the BoJ’s latest policy meeting, in which it announced it was continuing its asset purchase program at current levels while keeping interest rates very low. “Whatever fiscal, regulatory, or any other policies the new government pursues, the BoJ will continue to maintain extremely accommodative monetary policy in order to achieve its 2% price stability target as soon as possible,” Kuroda said, according to Reuters. In the latest data, Japanese inflation remained well below the central bank’s goal.


Chinese stocks ended a holiday-shortened week on a mixed note. The CSI 300 Index of large-cap stocks edged slightly higher, while the Shanghai Composite Index declined from the previous Friday’s close. China’s markets were closed Friday for the weeklong National Day holiday starting on October 1. In the bond market, yields on Chinese government bonds were broadly unchanged from the prior week. China’s currency, the renminbi (RMB), strengthened against the U.S. dollar 0.3% to 6.447 per dollar. Positive news concerning indebted property developer China Evergrande Group supported investor sentiment. On Wednesday, Evergrande said that one of its units would sell roughly 20% of its stake in Shengjing Bank Co. to a state-owned enterprise for USD 1.5 billion to help reduce its debt load. News of the asset sale came as Beijing is prodding government-owned companies and state-backed property developers to buy some of Evergrande’s assets, Reuters reported. Separately, the People’s Bank of China (PBOC) pledged to ensure a “healthy property market” and to protect homebuyers’ rights in a statement following the central bank’s quarterly monetary policy committee meeting. The PBOC has injd stresses in the short term. Some analysts also think that a cut in China’s reserve requirement ratio appears more likely if the economy continues to slow toward year-end. Despite the magnitude of Evergrande’s debt problems, T. Rowe Price investment analysts do not think that a default by the company will cause systemic risk in China’s credit markets. A more likely outcome is that there will be a well managed deflation of the company’s debt balloon. Though Evergrande ranks among China’s major developers, it accounts for a small amount of total revenue in a fragmented industry, and any impact to the country’s banking system will be manageable. Ultimately, Beijing will likely focus on managing the social fallout of Evergrande’s unfinished housing units, followed by property supply chain suppliers owed money by the company, T. Rowe Price analysts believe.


CHILE Chilean stocks, as measured by the S&P IPSA Index, returned about -1.4%. The market was hurt in part by rising longer-term U.S. interest rates, a stronger U.S. dollar versus the peso, and bearish global sentiment toward risk assets. Chilean assets were also hurt by growing expectations that a new bill allowing for pension system withdrawals—the fourth such legislation since the beginning of the pandemic—could soon become law. During the week, the lower house of Congress barely passed the legislation and sent the bill to the Senate, where it was initially expected to encounter considerable opposition from the ruling coalition. However, revelations that certain cabinet members have taken advantage of previous pension withdrawal bills are seen as weakening the administration’s credibility. To make matters worse, one of the leading presidential contenders of the center-right, Sebastian Sichel, also proposed that—if the latest pension withdrawal legislation becomes law—he would support a total liquidation of all Chilean pension accounts to prevent citizens’ savings from becoming part of a state-run system that several left-wing legislators are considering. PERU Peruvian assets were hurt by risk aversion among global investors. Also, investor uncertainty regarding Peru’s political situation remained high, as T. Rowe Price emerging markets sovereign analyst Aaron Gifford notes that fissures are becoming more evident within President Pedro Castillo’s cabinet and party. Specifically, there have been conflicting comments and opinions among Castillo’s allies with regard to nationalizations, which he had ruled out in his late-July inauguration speech, and rewriting the constitution, which Castillo favors but which does not interest many lawmakers. Meanwhile, despite indications that Julio Velarde—the head of the central bank and one of Peru’s top economists—will remain at the helm, no official pronouncements have been made yet. According to different sources, it seems that he has asked for guarantees from the president that include the nomination of board members that he would work well with even if they clash with the ideology of some of Castillo’s more radical allies.

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