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Market comment 4th June

Markets higher in quiet week as “meme” stocks grab headlines The major indexes closed moderately higher in a shortened trading week, with markets closed Monday in observance of Memorial Day. Energy shares performed best within the S&P 500 Index as oil prices reached their highest level in two years. Consumer discretionary shares lagged, weighed down by a decline in Tesla. Trading volumes were generally light, as is typical of the start of the summer holiday season. T. Rowe Price traders noted that volumes would have been lighter still if not for concentrated buying and selling by retail investors of what some have termed “meme” stocks—smaller-cap, consumer-oriented shares actively discussed on social media. Shares of theater chain AMC experienced particularly heavy trading and volatility. Jobs report sends mixed signals The strength of the economic recovery remained in the spotlight, with Friday bringing the closely watched monthly nonfarm payrolls report. The Labor Department reported that employers added 559,000 jobs in May, somewhat below consensus forecasts of around 650,000, while the labor force participation rate ticked down to 61.6% from 61.7%. On the positive side, the employment-to-population ratio—considered by some to be more important to Fed officials—ticked higher, and the unemployment rate fell more than expected, from 6.1% to 5.8%. Average hourly earnings rose 0.5%, above consensus and indicative of a tighter labor market. Although the report offered mixed signals, stocks rose and longer-term bond yields decreased on the news, suggesting that most investors expected it would give the Federal Reserve additional time to keep monetary policy highly accommodative. On Tuesday, Fed Governor Lael Brainard and Vice Chair Randal Quarles both stressed that significant slack remained in the economy and that the Fed was far from achieving its inflation and employment targets. They both stressed, however, that the Fed would be quick to act if the recent increase in inflation does not prove to be “transitory.” Much of the rest of the week’s economic data came in above consensus. Payroll processing firm ADP reported that its tally of private sector jobs increased by 978,000 in May, well above consensus expectations for a gain of 650,000. Restaurants and other leisure and hospitality businesses were responsible for 440,000 of the new hires, and IHS Markit’s gauge of service sector activity reached its highest level in records going back to 2009. Manufacturing signals generally remained strong, although construction spending grew less than expected, and construction employment surprised many by contracting a bit in May. Quiet week in fixed income markets After increasing early in the week, the yield on the benchmark 10-year U.S. Treasury note fell back on Friday following the May payrolls report. (Bond prices and yields move in opposite directions.) The broad municipal bond market outperformed Treasuries over much of the week, and our muni traders reported improvement in secondary market trading volumes as the week progressed. According to the latest data from Lipper, municipal bond funds industrywide received net inflows of nearly USD 1 billion for the week ended June 2, including strong flows into tax-exempt high yield portfolios. The corporate bond markets were relatively quiet. Investment-grade corporate bonds experienced relatively light trading volumes, and new issuance was in line with expectations. The high yield market was also fairly subdued, although our traders reported that news of progress in negotiations over a new infrastructure bill appeared to support sentiment, and outflows from below investment-grade funds subsided.


EUROPE


Shares in Europe rose amid optimism about the prospect of an economic recovery. However, worries that central banks might begin withdrawing stimulus sooner than expected because of inflationary pressures curbed equities’ advance. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 0.80% higher. Italy’s FTSE MIB Index climbed 1.59%, Germany’s Xetra DAX Index gained 1.11%, and France’s CAC 40 Index added 0.49%. The UK’s FTSE 100 Index rose 0.66%. Core eurozone bond yields drifted lower as comments from some policymakers contributed to expectations that the European Central Bank (ECB) would likely opt to maintain the pace of bond purchases at its June 10 meeting. Yields in peripheral European bond markets tracked their core counterparts. UK gilt yields largely followed the upward move in U.S. Treasury yields. UK mulls delaying full reopening; coronavirus infections decline in Germany In the UK, a sharp increase in cases of the highly transmissible Delta variant of the novel coronavirus stoked concerns among scientists and government officials, sparking a debate on whether lockdown measures should be fully lifted on June 21.Although the number of new coronavirus cases rose to levels not seen since late March, Prime Minister Boris Johnson said there was not yet enough evidence to delay a full reopening. In Germany, Chancellor Angela Merkel said she was ready to give up emergency powers, as the trend in coronavirus infections has been improving. The European Union is planning to lift all quarantine rules for those who have been vaccinated, starting July 1, and to introduce digital passports for travelers, according to The Guardian newspaper. Eurozone inflation exceeds ECB target; PMIs point to strong economic growth Eurozone inflation increased 40 basis points sequentially to 2% in May—above the ECB’s stated target of “below but close to 2%.” Higher energy costs were a big part of the increase in consumer prices. Core inflation, which excludes volatile food and energy costs, ticked up to 0.9% from 0.8%. Final purchasing managers' survey data for the eurozone confirmed a revival in the service sector that was accompanied by booming manufacturing activity. IHS Markit said the data indicated that gross domestic product (GDP) "should rise strongly in the second quarter." Meanwhile, retail sales in the bloc fell in April by a greater-than-expected 3.1% sequentially, although they rose 23.9% year over year on a calendar-adjusted basis. Unemployment in Germany fell more than expected in May.


JAPAN


Japan’s stock market returns were mixed for the week, with the Nikkei 225 Index falling 0.71% and the broader TOPIX Index gaining 0.60%. Sentiment remained weak following the government’s extension of the coronavirus state of emergency in Tokyo, Osaka, and seven other prefectures by three weeks to June 20. The yield on the Japanese 10-year government bond was little changed at 0.08%, while the yen weakened to close at around JPY 110.18 against the U.S. dollar. Household spending jumps by double digits Japan’s household spending rose 13.0% year on year in April after a 6.2% rise in March. The increase was the biggest since comparable data became available in January 2001. Consumers sought out beauty treatments, dining, accommodation, and domestic tourism packages. Autos and apparel also contributed. Spending picked up amid a temporary reprieve from the coronavirus restrictions, although gains were inflated in part by the sharp comparison with the pandemic-driven plunge over the same period last year. While the rise was larger than expected, worries remain about the pace of Japan’s recovery, with separate data showing that service sector activity shrank at a faster pace in May due to coronavirus restrictions. Service sector continues to shrink as coronavirus crisis hits demand The au Jibun Bank Japan Services Purchasing Managers’ Index (PMI) fell to 46.5 in May from 49.5 in the prior month, signaling a quicker contraction in business activity and marking the sharpest reduction since February as tighter restrictions weighed on output. New business declined at a faster pace, contracting for the 16th consecutive month. International demand for Japanese services has deteriorated as key markets around Asia have faced stricter restrictions due to a surge in coronavirus infection rates. Nevertheless, Japanese service providers increased staffing levels, and business expectations for the next 12 months remained positive, in anticipation of higher sales once the pandemic subsides. The au Jibun Bank Japan Manufacturing PMI edged down slightly to 53.0 in May from 53.6 in April, signaling a softer but still moderate improvement in the health of the manufacturing sector. A sustained expansion in both production volumes and new orders contributed to overall growth, while new export orders rose at a solid pace. OECD revises upward Japan’s growth projections The Organization for Economic Cooperation and Development (OECD) upgraded its projections for Japan’s economic growth: It projects GDP to expand by 2.6% in 2021 and by 2.0% in 2022. Furthermore, it expects Japan to recover to pre-pandemic levels of GDP per capita after the third quarter of 2021. The OECD believes that current coronavirus containment measures are likely to be maintained until the summer, but, as the restrictions are lifted and vaccination accelerates, economic activity will strengthen.


CHINA


Chinese stocks retreated after recording three weeks of gains. The large-cap CSI 300 Index shed 0.7% and the benchmark Shanghai Stock Exchange edged down 0.2%, according to Reuters. Foreign investors bought USD 8.7 billion of Chinese stocks in May, the highest single month this year, Reuters added. In the bond market, the downtrend in yields took a breather. The yield on the 10-year Chinese government bond (CGB) rose 2 basis points to 3.11%, a relatively high level compared with other major government bond yields. Over the last six months, Bloomberg's local currency index for CGBs returned 3.4%, while the spread over comparable 10-year U.S. Treasury yields tightened almost 100 basis points. In credit markets news, China's finance ministry plans to transfer its stakes in the country’s big four asset management companies into a new holding company, Bloomberg reported. The move would reduce the government’s controlling stakes in the state-run companies and aims to separate its dual roles as regulator and shareholder. In currency trading, the renminbi weakened slightly against the U.S. dollar to end at 6.40 per dollar. On the economic front, the private Caixin manufacturing PMI rose to 52.0, its highest reading this year as demand picked up. In contrast, the official manufacturing PMI fell slightly to 51.0. Macroprudential polices start to bite China's monetary officials continue to rely on macroprudential policies to tighten credit. On June 1, the China Banking and Insurance Regulatory Commission (CBIRC) warned smaller banks not to increase their property loans as bigger banks reduced their lending to the sector. Meanwhile, regulatory pressure to tighten the flow of capital to the property sector appeared to be working. Total onshore and offshore bond financing by developers fell 18% from January to May over the prior-year period to a three-year low, according to HSBC. As a result, many economists in China believe that residential construction activity will decline later this year and become a growth headwind. Property sector loans posted the slowest growth in eight years in April, according to the CBIRC. Baby boom not guaranteed after three-child rule After China’s surprise May 31 announcement that it would relax the current two-child policy and allow couples to have a third offspring, many economists believe that the measure will do little to alter the trajectory of the country’s looming demographic crisis. Many analysts point to the relatively low number of births that occurred the last time China relaxed its birth policy starting January 2016, when the government allowed two children per family.



OTHER KEY MARKETS


BRAZIL Stocks in Brazil, as measured by the Bovespa Index—which reached an all-time high during the week—returned about 3.5%. The market was closed for a holiday on Thursday. Equities—which advanced 9.64% in U.S. dollar terms in May, as measured by MSCI—continued to climb in the first week of June, supported in part by recent strength in the Brazilian real versus the dollar, as well as tighter credit spreads in the fixed income market. Also, recent economic data have been encouraging, including the 1.2% quarter-over-quarter reading for first-quarter GDP, which was stronger than expected. T. Rowe Price sovereign analyst Richard Hall observes that if Brazil sustains that level of output throughout the year, the country’s economic growth rate in 2021 would be 5%. In addition, trade data have been very strong, with April and May printing new seasonally adjusted highs for the country’s trade surplus, as Brazil sells its main crop—soy—at good international prices. Inflation, however, has been the one area of increasing concern. Despite the appreciating currency, the ongoing drought poses risks to both food prices and to energy prices. As Hall anticipated, the electricity regulator will impose the highest possible electricity surcharge in June due to low water reservoir levels. Stronger growth also suggests an output gap that will close faster and thus provide less of a disinflationary impulse. MEXICO Stocks in Brazil, as measured by the Bovespa Index—which reached an all-time high during the week—returned about 3.5%. The market was closed for a holiday on Thursday. Equities—which advanced 9.64% in U.S. dollar terms in May, as measured by MSCI—continued to climb in the first week of June, supported in part by recent strength in the Brazilian real versus the dollar, as well as tighter credit spreads in the fixed income market. Also, recent economic data have been encouraging, including the 1.2% quarter-over-quarter reading for first-quarter GDP, which was stronger than expected. T. Rowe Price sovereign analyst Richard Hall observes that if Brazil sustains that level of output throughout the year, the country’s economic growth rate in 2021 would be 5%. In addition, trade data have been very strong, with April and May printing new seasonally adjusted highs for the country’s trade surplus, as Brazil sells its main crop—soy—at good international prices. Inflation, however, has been the one area of increasing concern. Despite the appreciating currency, the ongoing drought poses risks to both food prices and to energy prices. As Hall anticipated, the electricity regulator will impose the highest possible electricity surcharge in June due to low water reservoir levels. Stronger growth also suggests an output gap that will close faster and thus provide less of a disinflationary impulse. What is notable to Gifford, however, is that the central bank has kept its forecast of inflation returning to its target of 3.0% by the second quarter of 2022. With regard to core prices, central bank officials raised their projections due to supply distortions in some goods and services, as well as a smaller output gap. In any case, policymakers continue to believe that recent inflation surprises are transitory, though their base case doesn't factor in potential upside risks to inflation. The quarterly inflation report’s commentary related to monetary policy affirms that policymakers’ interest rate decisions will remain data-dependent. In this sense, Gifford believes that the door for more interest rate cuts is closed. At the same time, he continues to believe that policymakers—despite being a bit more optimistic on the recovery—are giving few signs that they are in a hurry to hike short-term rates.

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