Yesterday’s continued slide in bond yields, along with a sharp fall in stock markets, appears to be painting a narrative that the reflation trade is dead or dying.
The slide in US 10-year yields this week appears to suggest that bond investors are becoming increasingly concerned about a sharp slowdown in global and US growth prospects, as well as diminishing inflation expectations.
As a consequence of the slide in yields the US 10-year hit a low of 1.25% on Thursday before bouncing, however it is still down 8bps this week, having shed 14bps in June.
The initial cues appeared to come from markets in Asia after Japan declared a state of emergency only days ahead of the upcoming Olympic Games. This action by Japanese authorities appeared to crystallise concern about rising infection rates across all of Asia, amongst populations that remain well behind in the vaccination stakes. Investors appear to have belatedly woken up to this risk and the potential economic damage that could well be done in the second half of this year, with South Korea announcing tougher restrictions in Seoul earlier today.
US markets followed European markets lower yesterday, although the losses were quite contained with markets closing well off their lowest levels of the day. Today’s Asia session has seen further weakness, although much of that was a continuation of the sell-off from Thursday, with today’s European open set to see a modest rebound, as investors weigh up whether this is simply another opportunity to buy the dip. This sort of angst is nothing new for markets, however the slide in yields is telling us that the recovery is either in trouble, or merely being delayed. Much is likely to depend on the vaccine rollout plans, and the speed with which it can be rolled out in the countries where cases are rising sharply.
This concern about inflation, or the lack of it also saw the European Central Bank announce a change to its inflation mandate yesterday, in an attempt to try and give itself more flexibility over monetary policy. Its previous mandate was to keep inflation at or below 2% over the medium term.
The new mandate gives the ECB a more flexible and dovish inflation target of 2%, while also adopting a 2% asymmetric inflation target over the medium-term. This would allow the central bank to tolerate temporary inflation overshoots to its policy target. While an entirely sensible measure on the face of it, this can only be described as a change of style over substance, given the ECB’s complete lack of success in meeting its previous mandate.
While there are legitimate concerns about rising Delta variant infection rates across the globe, the UK economy still appears on course for the next stage of its reopening process on the 19th July despite similarly rising rates.
What’s different in the case of the UK is lower hospitalisation rates, and though that could change, for now the recovery looks good. The latest UK economic data continues to point to a robust rebound as restrictions slowly get relaxed, with today’s focus on the latest industrial and manufacturing production data for May. These numbers are expected to reinforce this economic resilience if recent PMI data is any guide, though in the case of the April PMI’s the ONS numbers told a very different story.
We saw big declines in both manufacturing and industrial production of -0.3% and -1.3% respectively, in April, largely as a result of plant closures and a slip in mining and quarrying, while manufacturing slowed due to weakness in the pharmaceuticals sector. Construction activity also slowed, falling 2%, though this needs to be put into the context of a big 5.8% rise in March.
Despite this weakness the May numbers are expected to be much better with gains expected for both, with recent industry surveys showing output at record levels. Industrial production is expected to rebound by 1.4% and manufacturing by 1%.
We’ll also get the first look at the monthly May GDP numbers. Having seen Q1 GDP confirmed at -1.5% last week, the monthly GDP numbers have proved to be a useful bellwether of how the UK economy has been playing catchup after a poor start to the year, as the January lockdown and the Brexit transition period came to an end.
Starting with a -2.9% contraction, we’ve seen a slow and steady pick-up to economic activity with a 0.4% rebound in February followed by 2.1% in March and then a 2.3% expansion in April as the first set of restrictions were eased. With the May unlocking proceeding as expected and with services PMI hitting a 24 year high the latest monthly GDP for May is expected to see another 1.5% jump in monthly GDP, as the UK economy continues to accelerate out of the traps, pushing the 3M/3M rate up to 3.9%, from 1.5%, with services expected to lead the recovery, with a 1.6% expansion.
EURUSD – found some support at the 1.1780 area this week but need to push back above the 1.1870 level to reopen a move back towards the 1.1975, and the 200-day MA at 1.2000.
GBPUSD – the major support on cable remains down at the 1.3670 level and March and April lows. We also have minor support at the 1.3730 area, with resistance at 1.3870. We need to push back through 1.3900 to reopen the 1.4000 area.
EURGBP – continues to range trade between the 0.8530 area and wider resistance at the 0.8640 level. Bias remains for a move towards 0.8480 on a break below 0.8530, while below 0.8640.
USDJPY – yesterday’s break of the uptrend from the lows this year saw a big sell off towards finding resistance after peaking at 111.70 earlier this month. The next support comes in at 109.20 and daily cloud support. A break below 109.00 opens up a move towards the 108.60 area.
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