April 01, 2021 | 13:09
That Was the Quarter That Was… Intriguing
This year’s first quarter may have lacked the historic moves of a year ago, but it packed plenty of intrigue into 90 days. Arguably, the watershed event occurred in the very first week, when the Democrats won control of the U.S. Senate. That set in train President Biden’s massive $1.9 trillion fiscal package which, in turn, fired up U.S. growth forecasts and put the reflation trade on steroids. This was the defining feature for financial markets almost since Day 1, clobbering bonds, but juicing growth-sensitive equities and commodities. The latter were also supported by Saudi Arabia’s unilateral oil production cuts, a decision that (oddly) coincided with the Georgia Senate results. Markets didn’t have a fully one-way trip north in the quarter, though, punctuated by excitement around a certain gaming retailer and overextended hedge funds.
At the same time, the race between the virus and the vaccine intensified, with wide regional divergences in relative success. While “winners” are rare, it’s clear that much of Europe, and a few specific emerging markets (Brazil, Turkey) are still struggling heavily—and currency markets have taken note. And, if anything, growth divergences may widen further, as the quarter ended with President Biden proposing an even more massive infrastructure spending program, albeit funded by increased corporate taxes. Here is a brief recap of what these shifting tectonic forces meant for the outlook and various markets:
Growth revisions diverge: On balance, our view on 2021 global GDP growth has barely budged in the past three months, with a modest two-tick upgrade to 5.7% (and a six-tick hike for 2022 to 4.6%). But there were some big changes beneath that placid surface. By far and away, the largest upgrade was to the U.S. outlook, due mostly to the aggressive fiscal push, but also due to signs of a faster reopening of the economy alongside a rapid vaccine roll-out. We now look for U.S. GDP growth of 6.5% this year, a full two percentage points above the view at end-2020, which would mark the best annual performance since 1984. Canada has been pulled along for the ride, and we look for a similar growth rate here (up 1.5 ppts since the start of the year). The U.K. has also been bumped up 1 ppt to 6.0%. However, Europe has moved the other way, with the Euro Area now expected to grow just 4.0% this year (down 1.5 ppts). That nearly offsets the big revision to North America, while the view on China (8.0%) and Japan (3.5%) has stayed remarkably steady this year.
Bonds Away: Our view on global growth may not have changed that significantly over the quarter, but apparently the consensus became much more comfortable with the forecast of a robust rebound in activity. Combined with a further rise in inflation expectations, and even deeper U.S. budget deficits (i.e., bigger borrowing requirements), and bonds were walloped right out of the gates in Q1. Yields leapt the very first week, and rarely looked back, with 10-year Treasury yields touching a post-pandemic high of 1.77% just this week. When the dust settled on the quarter, the key feature was a dramatic bearish steepening of the curve, with Canada at the leading edge of the trend. Ten-year GoCs jumped 88 bps in the quarter, bringing them all the way back to around pre-pandemic levels above 1.5%, while 2s nudged up just a few bps. U.S. 10s were only a tad behind (rising 82 bps), as were the U.K., Australia, and New Zealand. No major market was fully spared from the sell-off, with even Japan’s 10-year yields up 7 bps in Q1. After a furious rally through the back-half of last year, corporate bonds stalled out, as U.S. spreads even widened a touch in the quarter.
Equities solid on surface, rotation below: While bonds dived, stocks thrived to start the year. Even with some Reddit-inspired diversions, the big picture is that major markets ended the quarter at or near an all-time high. The MSCI World index rose a sturdy 6.2% in Q1, and is less than 1% from its March 17 apex. Among the major markets we follow closely, Taiwan led (up 11.5%, on chips), followed close behind by Germany, France and the Dow; the theme was strength in cyclicals. The S&P 500 was mid-tier with a 5.8% rise (albeit, it promptly hit 4,000 for the first time ever on April1), held back by a so-so tech sector. After leading last year’s amazing revival, the Nasdaq trailed in Q1, though still eking out a 2.8% rise. Toronto was in the top third with a solid 7.3% advance, led by energy, financials, consumer discretionary, and, sigh, pot stocks. It wasn’t all green for the TSX though, as tech sagged slightly and materials slumped 7.2%.
Commodity Oddity: The pullback in Toronto’s materials sector looks wildly out of place amid the widespread reflation trade. The simple explanation is that precious metals went into reverse in the quarter, running against the grain of almost all other resource prices. Gold fell $191 (or 10%) in Q1, while silver was down 7.5% (despite a flurry of attention from the Reddit crowd). But these were the exceptions in the commodity space, as the broader theme was strength amid a global rebound. Oil was the big winner and the big story; while it backed off from its high, it still ended the quarter close to $60, a 22% jump. Similarly, copper lost some momentum but still finished close to $4, a 13% advance. Lumber remained extremely strong at above $1,000, powering up more than 15% in Q1, on robust home building prospects in North America. Even agriculture got into the act, with corn prices jumping 16.5%. Pulling it all together, the BoC’s commodity price index managed to rise more than 15% in Q1 (and the CRB was up 10.2%) and has more than doubled from the extreme conditions of a year ago.
Big Dollar’s Little Comeback: Making the Q1 rise in commodity prices even more impressive was the fact that it came amid a firmer U.S. dollar. Running against widespread expectations of further weakness, the greenback managed to rise 3.7% on a trade-weighted basis—its first quarterly gain in a year. The move lines up well with the divergence in relative growth outlooks on either side of the Atlantic, and the euro sagged 4% in Q1. However, the yen was the weakest advanced-economy currency, falling almost 7%, closely followed by the Swiss franc; their safe-haven status lost some draw, amid prospects for a robust global recovery. The weakest major emerging market currencies were in Brazil (-8%) and Turkey (-10%), although even China’s yuan slipped slightly in the quarter. One of the few currencies that managed to strengthen against the U.S. dollar revival was none other than the loonie which, in fact, was the global leader in Q1. An improved growth backdrop and the big bounce in Canadian commodity prices helped lift the loonie 1.3%, just nudging out the U.K. pound (up 0.8%), and even as the Aussie dollar slipped a similar amount.
One of the factors helping hold up the Canadian dollar in Q1 was a significantly improved domestic growth backdrop. And, financial markets remain set on the notion that the Bank of Canada will be a leader in starting to normalize policy—a notion that is not at all obvious. Perhaps adding a bit of fuel, Governor Macklem expressed some direct concern about the towering inferno currently ablaze in the housing market. That topic has already consumed plenty of oxygen, and we doubt that the Bank’s concerns on that front will translate into a significant change in monetary policy.
Something that could make more of a lasting dent on policy is the underlying growth backdrop. And this week brought yet more upside surprises for Canada on that front. Powerful gains in the goods-producing sectors early in the year more than offset renewed weakness in the high-touch service sectors. Perhaps the most staggering development was that Canadian GDP managed a solid 0.7% advance in January, during the height of the second wave lockdowns, and when employment fell more than 200,000. That resiliency is the main reason that we have bumped up our forecast for 2021 growth by half a point to 6.5%, even in the face of yet more restrictions amid the third wave now underway.