April 16, 2021 | 13:11
March (and April) Madness
It is becoming increasingly apparent that March was an absolutely mammoth month for the global economy, and especially for the world’s two largest. And, yet, despite a flood of powerful growth and inflation data in recent weeks, the most notable market reaction has been a pullback in long-term bond yields. After sprinting nearly 85 bps in the first quarter of the year to above 1.75%, or all the way back to pre-pandemic norms, 10s receded for the second week in a row to just below 1.6%. Calmer bond markets, solid U.S. bank earnings and a stronger recovery provided fresh fuel for equities’ record run, propelling the S&P 500 to nearly 4,200 and the Dow above 34,000.
It was a fast/furious week for the U.S. economy, but the two stand-out reports both landed squarely on the high side of expectations. CPI posted its largest monthly rise in more than a decade (0.6%), which, when coupled with a drop last year, lifted the inflation rate to 2.6%. While gasoline is driving the move, core is no wallflower at up 0.3% m/m and 1.6% y/y. These numbers are poised to step markedly higher in the next two months before relaxing somewhat. True, this inflation bulge has been on the market’s radar for many months, but the starting point is a bit higher than expected, while firm commodities and sporadic labour shortages suggest the pricing strength may persist.
Meantime, retail sales blew past expectations at +9.8% in March, and up a towering 35% annualized in Q1. No doubt, stimulus played an outsized role here; but, note that raw sales rose $135 billion from February, roughly double a “normal” March move, absorbing a small fraction of the $1.9 trillion package. The run of other major indicators was also mostly well above expectations, including a sub-600,000 reading on initial jobless claims (at last). On balance, we have pulled forward some of the expected strength for this year into Q1’s GDP estimate. Overall, we remain comfortable with our above-consensus call of 6.5% for annual U.S. GDP growth. (This is a slightly different measure than the Fed’s Q4/Q4 call of 6.5%; on that basis we are a bit stronger at 6.7%.) But the consensus keeps climbing—up another half point in the past month to 6.2%, and up a massive 2.5 ppts in just the past six months. Even Jay Powell sounded positively perky in a 60 Minutes interview, while the newest Fed Governor, Christopher Waller, opined that the U.S. economy is “ready to rip”.
China’s economy also flashed some serious strength in March. The latest raft of results was a confusing jumble, both due to the typical Q1 seasonal complications but also because of the odd comparison with last year’s pandemic shutdown. Eyes thus mostly glazed over at the mammoth 18.3% y/y rise in Q1 GDP, and the 30%+ jumps in exports, imports and retail sales in March. Instead, the focus was on a modest quarterly rise in GDP (just 0.6%), a mildly “disappointing” 14.1% y/y rise in industrial production, and a slide in the trade surplus. However, we would highlight the big picture: China just pulled off a spectacular V-shaped recovery, and domestic demand has joined the party (reflected in the 38% y/y import spurt). Policymakers are thus expected to slowly drain support, keeping annual GDP at around an 8.5% clip for the full year. Combined with last year’s modest, yet still impressive, 2.3% rise, the two-year average growth rate will clock in just below pre-pandemic trends at 5.4%.
While the two largest economies are shaking off the shackles, most of the rest of the world is still very much in the grips of Covid restraint (aside from Israel and the U.K.). Tight restrictions remain in place in much of Europe, while many Canadian provinces are eying even tougher measures to control record levels of new cases. Famously, for the first time in the pandemic, Canada is now reporting more new cases per capita than the U.S. on a rolling average and continues to lag on vaccination rates. Last week we set out all the reasons why we still believe that Canada can roughly keep pace with U.S. growth, even with this harsh virus reality. However, any significant new restrictions on activity by some major provinces may prompt a further cut in Q2 growth (we have already chopped it to 2%). While we believe that would just push back the coming bounce in activity, it would tend to clip this year’s annual rate and boost next year’s in sync.
Of course, the sectors that are able to keep operating in Canada and Europe are running hot. The resource sector has been a big source of support for the comeback in Canada, and oil prices powered up 6% this week to around $63. Even more impressively, lumber prices are going from strength to strength, surging above a record US$1200 this week, or about quadruple the pre-pandemic norm. This bitcoin-like surge has been driven by supply cuts last year, strong reno demand, and sizzling North American homebuilding. U.S. housing starts spiked to a 15-year high in March, and we expect a powerful result for Canadian activity for the same month (this report was delayed to Monday).
Robust housing starts are a direct reflection of the ongoing hot activity in the resale market, as North American home prices continue to climb apace. U.S. inventories of unsold homes are at record lows, while prices are rising well above a double-digit annual pace, with some metrics even threatening to eclipse 2005’s heady advances. But those gains remain almost quaint when stacked up against the record-shattering conditions in Canada. This week’s title refers to madness, and that is the only word to describe Canada’s current housing market conditions. Even with an all-time high on new listings in March, months of inventory are at an all-time low because of the tidal wave of demand. Just to distill it down to a single stat—seasonally adjusted sales for all of Q1 were 40% higher than the pre-pandemic record high for any quarter.
Canada’s calendar has two heavyweight events on deck for next week, with the Federal Budget on Monday, and the Bank of Canada’s Monetary Policy Report and interest rate decision on Wednesday. It doesn’t get much bigger than that. Housing will be the elephant in the room for both events, but we expect the Budget will mostly focus on a wide range of other topics. From an economics perspective, the biggest questions are: How much stimulus is planned for this fiscal year, and what do the deficit projections look like now? Spoiler alert—we expect a large chunk of the $100 billion mooted stimulus to be front-loaded into this year, possibly resulting in a deficit of around $175 billion.
Still, that’s less than half of last year’s blow-out figure, so we also look for the Bank of Canada to further slim QE buying, on technical grounds alone. The fact that global bond markets have calmed in recent weeks should give the Bank added comfort to proceed with less aggressive bond buying. And, finally, the scalding housing market may also play into the decision to taper. After all, if tapering leads to slightly firmer long-term bond yields, that’s a much more acceptable outcome with housing markets on fire.