January 08, 2021 | 13:52
In our 2021 outlook piece, published three weeks ago, we posed the question “From Pandemic to Pandemonium?” Apparently the answer is “yes”, but little did we know exactly what kind of pandemonium would be on offer so early in the new year. But while financial markets took a brief pause during Wednesday’s riot on Capitol Hill, they were having a pandemonium of their very own to start the year. On a variety of fronts, we saw important breakthroughs of market thresholds, with the biggest spark coming from the Senate run-off results in Georgia which handed Democrats a narrow win in all three government arms. Besides the Capitol doors, here are some of the most noteworthy breakthroughs on the week:
Global equities: 18k, 28k and 31k runs. Fresh record highs for global stocks, and especially of U.S. averages, are almost old hat by now, so all-time highs for the MSCI World and all major U.S. measures are not a shock. However, the TSX managed to drive through the 18,000 threshold for the first time, and finally managed to surpass the previous record high set last February. As well, it is notable that the S&P 500 moved above 3,800, the Dow pierced 31,000, and the Nasdaq punched through 13,000, all for the first time. Even Japan’s long-suffering Nikkei broke above the 28,000 level for the first time in 30 years (it really will be news if it ever returns to its all-time high of 38,915, set the last day in 1989… yes, 1989.) The prospect of much more forceful U.S. fiscal stimulus was the biggest driver for equities.
Treasuries: 1% and 2%. The 10-year Treasury yield pierced the 1% threshold for the first time since March, with the big move happening again on Wednesday after the Democratic wins in Georgia. The yield kept on rising through the week and was beyond 1.1% on Friday—up 19 bps on the week—even in the face of a soggier-than-expected December payroll result. True, yields are still down 70 bps from a year ago, or before the pandemic was making any market waves. But most of the upswing in recent weeks reflects rising inflation expectations and not rising real yields (which are still about -1% for 10-year TIPS). Another key breakthrough this week was that implied inflation broke above 2% for the next five and ten years, for the first time since mid-2018.
Oil above $50: One key factor also driving inflation expectations is sustained strength in commodity prices. After the ruinous price war in early 2020, oil prices have been grinding back up, mostly thanks to surprising discipline among OPEC+ members. This week brought news of further supply trims by Saudi Arabia and notable calm at the monthly OPEC meeting. While deepening restrictions in many key economies suggest the recovery in travel will be even further delayed, markets are impressed by the supply discipline, and are also no doubt benefitting from the general risk-on move in broader markets. For the first time since February, WTI thus broke above $50 this week. That’s still down from the 2019 average price of $57 (which also happens to be very close to the inflation-adjusted long-term norm), but it’s miles from last spring’s horror show.
Currencies crack key levels: As per usual through the pandemic, the forex market has been a bit lower on the drama scale than other markets, but there was still some important movement here as well. And, for a change, the broader U.S. dollar was not the big story. In fact, after taking a one-way trip south since last March’s peak, the greenback was little-changed on net this week. It can be asserted that the Democratic win in Georgia is dollar-supportive, given the prospect of heavier fiscal support (and the associated growth, inflation, and rate implications). Still, the Canadian dollar tested the 79-cent threshold (or $1.265/US$) early in the week, a full 10 cents higher than March’s low point. As well, the Chinese yuan pushed below the 6.5/US$ level, the strongest since mid-2018 (i.e., just when the trade war was first heating up). The yuan has appreciated by more than 7% y/y, driven by a much firmer relative economic growth performance as well as the likelihood of somewhat quieter U.S. trade relations—quieter, but not necessarily warmer.
Bitcoin through $40,000: Whether driven by rising inflation concerns, general financial market strength, or a modern day version of tulipmania, there is no debate that rising institutional interest is fuelling a rush into the most famous cryptocurrency. Bitcoin’s most recent gains are especially notable in the face of a choppy ride for gold recently. The yellow metal took a step back on Friday to around $1850, and was actually down on a week when inflation expectations were breaking higher—a notable divergence.
The market fireworks to start the year were not completely ignoring developments in the real economy. This week also brought a run of early results on how the global economy fared in December. And the overall take was “not bad, all things considered”. Purchasing managers reports from around the world were a mixed bag, and heavily dependent on what stage of restriction various economies were facing at the end of last year. But the overriding message was that activity was less negative in Europe, less positive in China, and surprisingly sturdy in the U.S. and Canada.
In Europe, the composite PMI rose almost 4 points to 49.1 last month from a soft November, with the service sector rebounding from very weak levels. Manufacturing activity remains solid, led by an upbeat 58.3 reading from the German factory sector. That country also reported a surprisingly strong 0.9% rise in November industrial production, leaving output down 2.6% y/y. While that latter figure may sound weak, it is another example of economic data returning to much more normal territory after the extra-terrestrial figures last spring. And, unemployment continues to confound in Europe (i.e., by staying so contained), with Germany’s rate holding fast at 6.1% last month and the Euro Area reporting a small dip to 8.3% in November. The decent news in Europe is somewhat overshadowed by extended lockdowns in many areas, as well as a very slow vaccine roll-out to-date. The U.K. has seen faster vaccine action, and saw its composite PMI push above 50 last month. But, of course that economy now deals with the reality of a Brexit trade deal: early reports suggest a relatively smooth start.
The only major reports from China this week were the bevy of PMIs, and the private sector releases all remained well north of 50 in December. However, both services and factories saw a small step back in growth, with the composite index thus fading slightly to 55.8. Even so, we continue to expect China to post about 8% GDP growth this year, following their world-topping 2% advance last year. Because their shutdowns came very early in 2020, and were intense, some of the year-over-year economic data are going to print some gaudy gains in the weeks ahead.
The U.S. also reported some surprisingly perky purchasing manager results for December, with both factories (60.7) and services (57.2) moving further above the key 50 threshold. Auto sales chimed in with a surprisingly decent 16.3 million units (up from 15.6 million in November). True, that’s still below the pre-virus trend of 17 million, but well up from last year’s low average of 14.5 million. Unfortunately, the most important indicator of the week ended proceedings on a sour note, with payrolls unexpectedly falling 140,000. The setback can’t be considered a shock in the face of new restrictions (we were expecting flat), and all of the weakness was in the hospitality sector, with even a few traces of strength elsewhere. Notably, markets were largely unfazed by the mildly disappointing jobs data, still looking ahead to much firmer activity later this year.
Finally, it was a remarkably similar story in Canada, where jobs fell on restrictions on restaurants, but PMIs and auto sales improved at the same time. In addition, Canada saw a nice rebound in consumer confidence at the end of the year, according to the Conference Board, and home sales soared yet again. While December is typically not a big month for real estate activity, sales still managed to surge more than 40% y/y nationally to what will almost certainly shatter records on a seasonally adjusted basis.
As in many other economies, the main point is that outside of the sectors directly affected by restrictions, activity is holding up well—in some cases, remarkably so. This suggests that there is still some serious upside risk to the growth outlook, notwithstanding the persistently dispiriting spread of the virus. And financial market action is clearly taking that upside risk on board. The prospect of even more forceful U.S. fiscal stimulus only reinforces that risk.
Fully appreciating that there are a lot—A LOT—of moving parts for financial markets at this time, but I just can’t let it go without mentioning that today marks the final episode of Jeopardy with Alex Trebek hosting. Whether you have viewed the show once or 10,000 times, one can appreciate his quiet talent. As a final small tribute: For the Daily Double, topic financial markets, this G7 economy saw the biggest decline in both GDP and its equity market among major countries in 2020. Answer: What is the U.K., Alex?