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Written by George Lin/Senior Investment Manager CFS
In April, a range of market developments as well as concerns about the safety of Coronavirus vaccines caused investors some apprehension as to the pace of immunisation and the strength of the global economic recovery. However, economic data released over April was generally strong, especially in the US. And unlike our experience in the March quarter, where bond yields reacted negatively to stronger economic data, we saw yields stabilise in April – strengthening share markets. By month’s end, the ASX 200 was up 3.5% while the Australian Dollar (AUD) traded at 77.2 US cents.
Global economic data released in April was generally strong.
The recovery in the global manufacturing sector accelerated further, with strong rises in the US and European Manufacturing Purchasing Managers’ Index (PMI). The Manufacturing PMI for China has been steady over the last few months, reflecting the country’s early recovery and, possibly, the less expansionary state of Chinese monetary policy. While it still lags, the Services PMI in both the US and China has continued to rise. European Services was hampered by earlier lockdowns but is starting to show signs of a recovery as some measures are eased in response to lower case numbers across the continent.
US economic data continued to beat expectations, signalling a faster-than-expected economic recovery.
In particular, US non-farm employment rose by a much stronger than expected 916,000 positions in March. This is by far the strongest monthly job growth since August last year when the US economy re-opened after the initial lockdown. Leading indicators, such as the number of job openings, are pointing to further gains in employment. The easing of social restrictions and the latest transfer payment under the Biden fiscal plan led to a strong 9.4% surge in March US retail sales. While the same level of growth is unlikely to be repeated in April, improvements in the labour market and in consumer confidence point to continuing strength in US consumer spending.
Australia continues to make a strong recovery from the pandemic-induced recession.
Employment rose by more than 70,000 in March, the sixth consecutive monthly rise in employment. Australia has now recovered all lost jobs during the pandemic. In fact, the level of employment was higher than the pre-pandemic peak in February 2020. Retail trade rose 1.4% in March – the strongest monthly rise since November 2020, reflecting steadily improving consumer confidence driven by a combination of positive pandemic news and rising house prices. There is also good news on inflation. The Australian Consumer Price Index (CPI) rose 0.6% on a quarterly basis and 1.1% on a year-on-year basis over the March quarter. Further, the Reserve Bank of Australia’s preferred measure of underlying inflation rose 1.1% on a year-on-year basis. While the low price increase is reportedly distorted by some one-off changes, it seems inflation remains low despite the strong recovery in economic activity – meaning, the central bank will maintain a low-interest rate regime for longer.
Still Some Risks Ahead
It seems the main risk for world financial markets is another sharp rise in global bond yields, triggered by significantly higher inflation.
Investors expect a rise in US CPI inflation due to the base effect, tighter labour markets and upstream price pressures. The consensus is that this spike is transitory and will revert towards the midpoint of the US Federal Reserve’s (the Fed) inflation target of 2–3% by the end of 2021. If US inflation turns out to be higher and more persistent, bond investors will likely be aggressive in response and drive US bond yields higher. The speed and magnitude of a rise in bond yields could be a key influence on share markets. As in the March quarter, growth stocks (which are dependent on a distant rise in future earnings to justify their high valuations) may be particularly vulnerable to higher bond yields.
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