February 19, 2021 | 13:49
Steeped Texas Tea
It was precisely one year ago that equity markets, coming off fresh all-time highs, first began to get seriously rattled by the spreading virus in China. In the ensuing days, a string of new cases emerged in places as diverse as Korea, Iran, Italy and, eventually, North America, unleashing a five-week brutal downdraft in global financial markets. What’s astonishing is how much has changed since then, and yet, in other respects, how little has changed on balance. For example, a big bounce in government bond yields this week lifted 10-year Treasuries and GoCs all the way back to levels last seen in late February 2020. A deep freeze in Texas helped fire up oil prices back above $60 for a spell for the first time in over a year. Meantime, even with a mid-week stumble, global equities touched a new high and are up 15% y/y (MSCI World), remarkably similar to the gain reported a year ago.
Ah, you may be thinking, but the economy is completely different. With major portions of the service sector still effectively shut, or nearly so, jobless rates are well above year-ago levels (and probably still understated, in many cases). And with overall activity far below potential, government deficits remain bloated and debt levels have surged. Yet, the portions of the economy that are relatively open have come all the way back. A few prime U.S. examples from January just this week included a powerful surge in retail sales (up 7.4% y/y), manufacturing output rising within 1% of pre-pandemic levels, and housing starts almost precisely in line with year-ago levels.
This is not at all to downplay the very real pain in the various sectors that are directly affected by restrictions. Instead, the point is that industries that are able to operate are operating amazingly close to pre-pandemic levels. And this brings us back to the fundamental issue of whether another big wave of stimulus is fully appropriate in the year ahead. Recall, that the U.S. is just now feeling the impact of the (seemingly long forgotten) $900 billion in new measures that were just signed into law at the end of 2020. The big snap-back in retail sales was no doubt juiced by the $600 pay-outs to individuals, and there could be more room to run. Note that retail sales in unadjusted terms were up “just” $28 billion from a year ago, absorbing just a fraction of the fiscal support.
The sustained upswing in bond yields may also be flagging some growing concern that policymakers are at risk of overcooking conditions. This week alone saw the benchmark 10-year Treasury yield rise a spirited 15 bps to 1.36%, the highest in almost a year. This upswing has also reinforced the significant steepening of the yield curve, a key bond market theme so far in 2021. For example, the 10s/2s curve widened out to 125 bps (as 2s held fast), up from almost flat a year ago and the widest in four years. Some of the back-up in long-term yields has reflected a very recent upward nudge in real yields, but the bulk of the move reflects an increase in inflation expectations. At one point this week, the 10-year breakeven inflation rate rose to 2.24%, the highest since 2014, and up about 50 bps from pre-pandemic trends. The key point here is that even with the deepest global economic downturn in generations last year, investors expect inflation to average half a point higher over the next decade than they did before the pandemic.
And, this is not a quirk in the Treasury market, as GoC yields have rocketed even more impressively in recent weeks. The 10-year yield shot up 19 bps this week to above 1.2%, and the breakeven inflation rate has risen to almost 1.7%. True, that’s still well below the expected inflation embedded in the U.S. market, but it’s also up about 30 bps from a year ago. The key economic data point for Canada this week was January inflation, which—as if on cue—printed a bit hotter than expected at +0.4% m/m in seasonally adjusted terms (and 0.3% for ex food and energy). True, this left the yearly headline inflation rate at a still-mild 1.0% y/y pace, but it is poised to take a run at 3% in coming months, as it will be compared with the extremely low conditions of a year ago, and amid rapidly rising commodity prices.
The surge in commodity prices took on a more prominent role this week, with the Texas freeze sending WTI north of $60 and natural gas prices well above $3. But beneath those headline events, which are likely to fade, there were a few other more fundamentally driven price pops. (And, no, we’re not talking about bitcoin taking a trip above $54,000, lifting its “market cap” to $1 trillion.) Lumber hit the $1,000 mark for the first time ever amid the strong outlook for North American housing. Even with a January slide in starts, U.S. permits neared 1.9 million, the highest in almost 15 years. Existing home sales stayed strong even amid a dearth in supply, lifting median prices 14% y/y. And, of course, Canada’s housing market is even hotter, with starts vaulting to 282,000 last month (amid then-mild weather), sales up 35% y/y, and MLS prices chugging 13.5% y/y. Not totally unrelated, copper prices remain on a tear, nearing $4/pound for the first time since the go-go days of a decade ago, and up roughly 50% from pre-pandemic levels.
There’s nothing obvious on the economic calendar for the coming week to necessarily derail the steepening freight train. The U.S. will be cluttered with a variety of housing indicators, which will likely continue to flash strength, while February consumer confidence will be telling. Friday’s personal income and spending will give a broader sense of how households were affected by the $600 payments (i.e., the savings rate likely took another big step up even with a 5.3% jump in retail sales). In Canada, BoC Governor Macklem is speaking on Tuesday, with a press conference, and the topic is COVID’s impact on the labour market. While the recent sprint higher in oil and other commodities may have some looking for a slightly more upbeat tone, the back-up in yields, the Canadian dollar, and—maybe most importantly—the unemployment rate (to 9.4% in January), point to a relentlessly dovish message ahead.
We revised our U.S. GDP growth forecast for 2021 higher this week by a full point to 6%. The key factors behind the revision were: 1) the growing prospects for an even larger-than-expected fiscal support package (i.e., well above our earlier assumption of just under $1 trillion) and, 2) more signs that the U.S. economy was much more resilient than expected at the start of the year. Most of the upward revision is piled into the opening months of 2021, so our 2022 call holds steady at a still-solid 4%. Quick reminder: a 6% growth rate would be the strongest annual gain since 1984, albeit following the deepest annual decline (-3.5%) in the post-war period.
Even as we bump up the U.S. outlook, our Canadian call of 5.0% growth for this year (and 4.5% for next) is holding fast. The sustained upswing in a broad array of commodities is great news for the outlook, as is the ongoing surge in housing activity. However, the economy is still dealing with the reality of tighter restrictions than stateside. There was a flurry of wildly mixed stats for the turn of the year this week, but generally they revealed retail sales stumbled badly (falling more than 3% in both December and January), while manufacturing volumes fell at the end of 2020 even as wholesale trade spiked to start 2021. A jumbled picture indeed. The GDP release at the start of March, covering Q4 and December and with an early read on January, should help clear the picture somewhat. We still suspect growth was surprisingly snappy in Q4, but will stall temporarily in Q1.
That latter point is still very much a matter of ongoing debate. Recall that the Bank of Canada, for one, is expecting a notable pullback in Q1 GDP (-2.5% annualized). And that seems entirely reasonable given the big drop in January jobs, retail sales, and broad shutdowns in place at the start of the year. And, yet, hours worked are up solidly, housing is on fire, and wholesale trade surged out of the gates. Meantime, we now look for solid Q1 growth in the U.S., while the Atlanta Fed’s GDPNow is estimating a 9.5% sprint in the quarter. As we detailed in this week’s Focus, the gap between U.S. and Canadian growth could remain wide for some time yet, with such different vaccination trajectories, at least to this point.