We are halfway through the second quarter. Interest is not so much on Q1 data, even though Japan will report GDP for the January-March period. April data may also get short shrift as May reports begin tricking in. Even the May data may be overwhelmed, but the growing sense that the investment climate is changing.
Investors accept that the vaccine rollout plus fiscal and monetary support to varying degrees and pent-up demand will give the major economies a near-term lift. However, as the recent US employment data seemed to suggest, the recovery, even under the best of circumstances, is likely to be bumpy and uneven, driven by a lack of uniform re-opening and supply chain disruptions. Strong demand in some sectors is coming at the same time some supply constraints (e.g., shortages, bottlenecks, low inventories, and geopolitical issues, including the cyber-attack on the largest US gasoline pipeline and blacklisting of Huawei and SMIC, China's largest chip manufacturer).
To be sure, it is not just in the US that inflation expectations are elevated. Germany's 10-year breakeven is at the upper end of where it has been for the last seven years. It was last below 1.0% on February 22 and approached 1.50% last week. Since the end of Q1, the UK's 10-year breakeven moved above 3.50% for the first time since 2008. Japan's inflation expectations are nothing to write home about, but with the 10-year breakeven it 20 bp is back to pre-Covid levels.
The UK reports April CPI on May 19. A small month-over-month increase will lift the year-over-year rate to about 1.0%, matching the high from last July. Last April, UK headline CPI fell by 0.2%. That speaks to the base effect, for which we are now all familiar. However, there is another element of the current inflation that we need to monitor, supply chain and bottlenecks.
To capture that, we have been tracking the three-month annualized pace. For example, in the US, the January-through-April CPI rose at an annualized rate of a little more than 6%. In the UK, the Q1 headline was less than 1% at an annualized pace. Indeed, the UK's CPI in Q4 20 was the same as in Q1 21. In contrast, in Q4 20, US headline CPI rose at about a 2% annualized pace.
Despite large budget deficits, gross debt, and a central bank balance sheet that is a multiple of the Fed's (~130% of GDP vs. ~36.5%), Japan has still not arrested deflationary forces. Headline inflation was -0.2% year-over-year in April. It has not been above zero since last August, and it has not been above 1% since October 2018. The core rate, which in Japan excludes fresh food, was at -0.1% year-over-year in March. It was last above zero in March 2020. Although the formal target is 2%, it has not been over 1% since March 2015, and even that is not all that it appears to be. In April 2014, the sales tax was hiked from 5% to 8%., temporarily lifting the measured inflation.
Japan will report Q1 GDP on May 18 in Tokyo. A resurgence in covid and the response means that the world's third-largest economy contracted around 1% quarter-over-quarter after growing by 2.8% in Q4 20. However, the market badly underestimated March household spending. This suggests that the private consumption component of GDP, which the median forecast in Bloomberg's survey projects to be -1.9%, may be a bit better. Still, the economy is struggling, and a stronger recovery may have to wait for the second half of the year. The GDP deflator, another measure of price pressures, is expected to have returned to negative territory (year-over-year) for the first time since Q4 18.
Economists expect that Japan's net export function was a small drag on GDP. Japan's trade surplus averaged JPY182.2 bln in Q1. In Q2 20, the average monthly trade surplus was near JPY652 bln, the largest three-month average surplus since April 2010. Japan reports its April trade balance on May 19. There appears to be a strong seasonal component. Over the past 20 years, Japan's trade balance deteriorates March to April in all but three years. May is even worse. In the last 20-years, May's trade balance has improved on April's twice, and once was last year. Improvement is nearly always seen in June (only one deterioration in the past two decades).
Several central banks, not only the Federal Reserve, emphasize the labor market's performance in calibrating monetary policy settings. Following the dramatic miss in the US and Canadian April employment reports, attention turns to Australia and the UK's latest labor market readings. Last week, we learned that although the UK economy contracted in the first quarter, it was primarily because of the dramatic hit related to the new covid related restrictions. The economy accelerated with strong momentum going into Q2. Economic activity is picking up, and the UK is on track for economy-wide re-opening on June 21. The UK's furlough program is still in full gear. The government pays for 80% of employees' hours that cannot be worked. In July, that share falls to 70%, and employers are responsible for 10%. In August and September, when the program ends, the government will pay 60% and employers 20%.
Australia's April job data will be reported early on May 20 in Sydney. The Australian labor market has performed amazingly well. Consider three metrics. First, Australia lost 400k full-time positions in the March-June 2020 period. It has recouped 365k full-time jobs since then. Second, it shed 533k part-time posts (in April and May 2020) and has subsequently added 610k. Second, the unemployment rate peaked last year at 7.5% and has since fallen back to 5.6%. It was at 5.1% in November and December 2019. Moreover, the participation rate stood at 66.3% in March compared with 65.9% at the end of 2020.
In addition to the real sector reports, May survey data will roll out. It began with Germany's May ZEW survey last week that showed investors more optimistic about the future and less pessimistic about the current situation. After that, the US Empire State and Philadelphia Fed's manufacturing surveys are released, but the big one is the preliminary PMI reports. In the current context, which is characterized by stronger growth in most high-income countries, the PMI is really more about expectations of the pace of growth than the absolute numbers themselves. The other notable element is the relative strength of the manufacturing PMI and service PMI. For example, in the US, UK, and China, the service PMI is above the manufacturing. This seems to reflect the re-opening, while in Japan and the eurozone, where the vaccine rollout lagged, the manufacturing PMI is about the service PMI.
Two other reports are noteworthy. First, the US reports April housing starts and new home sales. Don't let the noise hinder the signal. The housing market is strong. Housing starts surged by 19.4% in March to reach nearly 1.74 mln unit seasonally adjusted pace. Such activity was last seen in 2006. To put it in perspective, it was about 1.57 mln in December 2019 and 1.67 mln in December 2020. The pullback economists are looking for is small and ought not to detract from the underlying strength.
The same is true for existing home sales. Even after falling in February and March, existing home sales are still at loft levels, not seen since 2007. Anecdotal reports suggest a critical headwind is supply. In March, there were 1.07 mln homes for sale, which is more than a quarter less than a year ago. That means that around the current pace of sales, there are a little more than two months of supply. In the industry, anything less than five months is regarded as a tight market. This imbalance is most immediately addressed by rising prices and fast turnover. The National Association of Realtors reported that the average property was on the market for a historic low of 18 days, and nearly 85% of houses were on the market for less than a month.
The second noteworthy report comes from SWIFT. We share two observations. First, the yuan's share has trended higher in recent months and in March was just shy of 2.5%. That is its greatest share in six years. There is much consternation over China's introduction of a digital yuan, which Niall Ferguson has said was Beijing "minting the money of the future." Yet, the yuan's low use is not a function of technology but of restrictions, lack of transparency, and the fact that the currency is not convertible. A digital form of the yuan does not change the facts on the ground.
Also, the monthly SWIFT report is a good reminder that mainstream digitalization is well advanced, without crypto. For example, consider that trade payment and portfolio flows are already largely digitalized as electronic messages on SWIFT that instruct banks to credit and debit specific accounts. Ransomware demanding crypto payment reinforces official misgivings about how crypto is being used outside of a trading asset.
Once again, buying the pullback appears to be serving short and medium-term participants well. The NASDAQ dropped nearly 9% from the end of April's high through last week's lows and came roaring back. European bond yields rose to the year's high last week, and are rising faster than US yields. The flurry of Fed officials that spoke in recent days concurs it is too early to even begin talking about tapering. It is difficult for the greenback to find much traction with this backdrop. The bond vigilantes that made a fuss after the CPI were quieted and the significant miss on retail sales may drive them back into hibernation.
Disclaimer
Reviewed by Marc Chandler
on
May 15, 2021
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