The US dollar extended its recent gains even as the yield on the 10-year Treasury pulled back by more than 15 basis points. The euro, the 7-Up to the dollar’s cola, fell to its lowest level since last November and the greenback rose to new highs for the year against most of the major currencies, save sterling and the Canadian dollar.
While recent US data have prompted some scaling back of Q1 GDP forecasts, 5%-6% still likely puts it atop the major economies. Fed officials’ latest projections showed a median GDP forecast this year at 6.5% (range 5.0%-7.3%). The median forecast in the Bloomberg survey is 4.8%. The survey also found that economists look for growth to peak around 7% at an annualized pace in Q2 and Q3.
Although several US states are reporting higher contagions, the acceleration of inoculations is set to continue. More states are making the vaccine available to all adults well ahead of schedule. No country is matching the US fiscal and monetary stimulus and success with the vaccine rollout. The UK economy may open a couple weeks before the US, but most of its growth in Q2 will be needed to offset the contraction in Q1.
The week ahead will be shortened in Europe by the extended Easter holiday. Still, four economic reports will help fine-tune perceptions of the pergence: US employment data, eurozone inflation, Japan’s Tankan Survey, and China’s PMI.
The US March jobs report will be released on April 2, Good Friday. It is arguably the most important of next week’s economic data points. The Fed now targets the average rate of inflation and puts more emphasis on the labor market, which several other central banks also appear to be doing. The previous language about “full employment” has also been eschewed in favor of maximum and inclusive employment references.
Some 9.5 mln fewer Americans are working now than on the eve of the pandemic. This may be the most important economic fact fueling the Fed’s stance. Several other central banks seem to be putting more emphasis on labor market developments. The US economy grew nearly 380k jobs in February (465k private sector positions), and the pace is expected to have accelerated to around 580k in March. We suspect the risk is on the upside, given the better weather, the improvement in the weekly jobless claims, and the anecdotal reports of more foot, auto, and air travel and restaurant bookings.
Fed Chair Powell has said essentially the same thing about the labor market with a little less fanfare and drama than ECB President Lagarde’s recent discussion of the holistic and multifaceted approach to financial conditions. In addition to job growth, he said the Fed looked at several metrics. Consider the unemployment rate. It was at 6.7% in the last two months of 2020 and 6.2% in February. It is expected to have fallen to 6.0% in March. That would be the lowest since March 2020 (when it was at 4.4%). In the six months before the pandemic struck, the unemployment rate bounced between 3.5% and 3.6%.
The last time the Fed hiked rates was December 2018. The unemployment rate was 3.9%. Before the pandemic, it cut rates in July, September, and October 2019 when the unemployment rate was in its 3.5%-3.6% trough. However, the immediate threshold is not about raising rates but when there is “substantial further progress” toward the Fed’s goals to allow tapering. Making some conservative assumptions, from the information set the Fed had at its March meeting to the mid-year meeting, another 1.1 mln or more jobs would have been created, and the employment rate maybe around 5.7% and falling. Assuming no fresh setbacks, the vaccine will be available to most US adults by then, and a more vigorous opening of the economy is likely. By then, too, the most potent part of the base effect on inflation will be peaking.
In fact, in June 2020, the PCE deflator increased by 0.5%. The June 2021 figure will not be reported in time for the June FOMC meeting, but as last June’s drops out of the year-over-year comparison, it may help ease the anxiety. At the same time, it reinforces the message from Fed officials that most of the rise is technical and temporary, which is essentially the same message from the ECB. Approaching maximum employment before the crisis did not spur intense price pressures.
On the last day of March, the preliminary estimate of the eurozone’s CPI will be reported. Lagarde has already taken the sting out of any upside surprise. She patiently went through the CPI basket at the ECB’s press conference and provided evidence for the judgment that the rise of from -0.3% in the last four months of 2020 to 0.9% in the first two months of 2021 was due to statistical quirks, like the temporary German VAT holiday, or when Italy or France have the sales specials. She also noted that the weighting of the basket changed to reflect 2020 consumption patterns.
With the March read, the base effect may act as a depressant. In March 2020, the aggregate CPI rose by 0.5%. That will drop out of the index and most likely be replaced with something less. It suggests a decline in the 0.9% year-over-year rate. Other influences are mixed. Oil and the euro declined so far this month, but the other technical factors may be more influential on the 1.1% core rate.
The ECB’s latest staff forecasts anticipate that the regional economy will contract by 0.4% in Q1 (quarter-over-quarter) before rebounding to 1.3% in Q2. Bloomberg’s survey found a median projection of -0.9% and 2.0% for the first two quarters, respectively. Judging from last week’s preliminary March PMI, the quarter is ending with decent momentum. The composite PMI rose to 52.5 (48.8 in February), which is the highest since last July’s peak at 54.9. It may overstate the case a little given the new contagion wave and lockdowns, but the economies appear to have begun showing resilience.
Japan’s economy appears somewhat less resilient. The preliminary March composite PMI ticked up to 48.3 (from 48.2 in February). It finished last year at 48.5, the highest since bottoming in April. The Tankan Survey is likely to confirm that the economy is likely contracting. Also, the survey will likely underscore that small businesses are facing more challenges than large, and their outlook is more pessimistic. After expanding by 2.8% in Q4 20, the Japanese economy may be contracting by a little more than 1% in the first three months of 2021. The economy is expected to snap back in Q2, but the weak momentum in March warns of potential disappointment.
China’s manufacturing and non-manufacturing PMI have fallen for three consecutive months through February. The manufacturing PMI has fallen from 52.1 last November, which was the high for the year, to 50.6 in February, distorted by the lunar New Year holiday. The non-manufacturing PMI fell to 51.4 from the 2020 high set in November at 56.4. The time series is not particularly long, but it appears that March’s composite PMI has consistently improved from February. There is no reason to expect this pattern to be broken.
Press reports and anecdotal stories suggest that China’s appetite for industrial metals has slackened. The idea is that part of the demand had reflected the building of inventories, and this apparently has been satisfied. At the same time, foreign portfolio managers who had been enthralled with Chinese bonds and equities appear to be having second thoughts.
The 10-year premium that China offered over the US was more than 220 bp at the end of 2020 after peaking near 250 bp in the middle of November. It is now holding just above 150 bp. Chinese equities have been a disappointment in the first part of 2021. The Shanghai Composite is off more than 3%, and the Shenzhen Composite has fallen 7%. Efforts by the government, reported in the press, were largely ineffective. It is the worst-performing large market.
For all practical purposes, the yuan is flat against the dollar (~-0.20%). Yet, those 20 bp are a third of the quarterly yield pick-up for the Chinese bonds over US Treasuries. Russia and Turkey have played up the need for an alternative to the dollar and “Western” payment system. Chinese officials appear to have kept quiet. A more significant role for the yuan requires it to be freely convertible, and they do not seem ready to surrender that kind of control. The three-month actual volatility is about 1.7%. Only the pegged Hong Kong dollar has lower volatility than the yuan.