Markets Weekly podcast - 14 June 2021

Henk Potts (HP): Hello. It’s Monday, 14th June and welcome to Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist for Barclays Private Bank, and each week I’ll be joined by guests to discuss both risks and opportunities for investors. Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week.

We’ll then discuss whether the consumer can drive the post COVID recovery. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Last week the showdown between resurgent inflation and central banks took centre stage. We had the US inflation report and Chinese PPI figures released, and the European Central Bank had to make a decision on the pace of asset purchase. But all eyes are very much focused on the US inflation report for May.

Elevated numbers were expected and the print certainly didn’t disappoint.  In fact, it exceeded economists’ forecasts by some margin.  CPI rose 5% year on year, that’s the largest gain since 2008 and we should remember that was at a time when crude was trading around $150 a barrel.

Core inflation rose 3.8% on an annualised basis, the fastest gain since 1992. The increase, which of course was distorted by base effects, was primarily driven by rising prices for used cars, for airfares, household goods and apparel.

The report I think highlights the reopening of the economy is creating transitory price pressures in affected categories. In fact, without the rises in those four segments headline and core inflation is estimated to only have been up around about three tenths of 1% month on month.

But we are starting to see some firming of underlying inflationary pressures. Peak CPI forecasts have been revised higher. We now look for core inflation to be at 4.1% at the end of the year, then easing back through the course of 2022 to finish next year at 2.2%.

The Fed’s preferred measure of inflation, core PCE, has been revised up as well but less than we’ve seen in terms of headline inflation but still looks set to overshoot the 2% target over the course of the next few months.

However, medium term forecasts still suggest that the economy is not yet on course to generate sustained inflation significantly above the target level once full employment has been obtained. 

Market reaction I think was interesting. Bond markets signalling that investors are certainly buying into the belief that the spike in inflation will indeed be temporary. Ten-year treasury yields fell 9.7 basis points last week. That’s the steepest weekly decline we’ve seen since 12th June 2020. On Thursday yields hit their lowest level since 2nd March at 1.43%.

Data last week also showed a rapid rise in Chinese producer prices. Surging commodity prices drove up China’s factory gate inflation to the highest level since 2008 in May.

Producer Price Index surged 9% year on year. Local commodity prices we know have been driven up by a mixture of stronger global demand as well as domestic hoarding and speculation.

Concerned Chinese authorities have begun to introduce restrictions on commodity trading activities. They’ve also been considering price caps and have hinted at releasing strategic reserves in an effort to improve supply and curb price growth. Thus far, producers appear to be absorbing the increase in input costs which has been squeezing margins rather than passing it on to consumers.

While consumer inflation has been picking up from low levels over the course of the past few months May’s headline CPI print was still relatively subdued at 1.3%. However, we do forecast the upward trend in core services inflation will continue as China gradually lifts COVID containment measures and consumer sentiment improves.

We forecast that CPI will peak at 2.9% in the fourth quarter before easing back to average 2% during the course of next year. Markets will certainly be watching the incoming Chinese data very carefully as rising producer prices in the world’s largest exporter adds to the evidence of growing global price pressures coming down the line.

Finishing off with the European Central Bank by the Governing Council kept financing conditions very accommodative by maintaining the pace of purchases and offered a dovish tone in the press conference referring to the highly uncertain economic and medical outlook and no meaningful change to the subdued medium term inflation outlook.

Even a slight reduction of the pace of purchase could have been interpreted by the market as tapering and jeopardised the result of the recent more dovish communication on easing financing conditions. In terms of the growth forecasts, staff revised up growth forecasts for both 2021 and 2022 by 0.6 percentage points to 4.6% this year, 4.7% during the course of 2022.

If you look at their growth forecast for 2023 it was unchanged at 2.1%. Despite the growth upgrade and the inflation outlook story in Europe still remains essentially unchanged.

The European Central Bank maintaining that headline inflation will remain affected by temporary measures so they think inflation will average 1.9% during the course of this year but have got pencilled in just 1.5% average during the course of 2022.

However, sizeable economic slack implies subdued underlying inflationary pressure over the course of the medium term with core inflation only reaching 1.4% due by the time that we get to 2023 meaning the European Central Bank will remain accommodative for the foreseeable future.

Turning to the policy outlook, well, if the recovery does materialise as robustly as the forecast suggests then there will indeed be pressure on the European Central Bank to consider scaling back purchases at their September meeting but still expected to maintain a large scale quantitative easing programme during the course of next year.

Turning to equity performance. On Friday the S&P 500 notched up its first all-time high since early May, was up four tenths of 1% over the course of the trading week. The NASDAQ rose on Friday for a sixth straight session. European stocks rose for a fourth straight week also hitting a new historical high. STOXX 600 was up 1.1% over the week with cyclical sectors very much leading the gains.

So that was the global economy and financial markets last week. What we do know is the global economy suffered its worst performance since the great depression last year. A slump in household demand was certainly a key element of the contraction as local lockdown restrictions were implemented.

However, there are increasing hopes that the reopening of the economy as the unleashing of pent up demand will indeed generate a powerful consumer led recovery. To discuss this, I’m pleased to be joined by Julien Lafargue.  He’s the Chief Market Strategist for Barclays Private Bank.

Julien, great to have you with us today.  Let’s start by considering the size of the opportunity. When you look at personal balance sheets what do they tell you about the health of the consumer?

Julien Lafargue (JL): Thank you very much for having me, Henk. So if you look at the consumer, the global consumer according to credit rating agency Moody’s, global consumers have accumulated about $5.5 trillion over the last few months.

In the US in particular overall disposal income went up 33% between March 2020 and March of this year. Since then it’s come down a bit but on aggregate US consumers have more money today than they had before one of the worst recessions in history, at least in magnitude.

So on paper the consumer is in great shape. Now as always with macroeconomic data it’s important to look at the details. Averages are usually misleading. And it’s not really different here as people who save money are those who could actually afford it.

People living paycheque to paycheque haven’t really had necessarily a massive improvement, or have seen a massive improvement in their financial wellbeing. And similarly while there’s a lot of money sitting in bank accounts the key question remains whether it will be spent or will it stay idling because consumers are afraid of what may be ahead.

Here the good news is consumer sentiment has been improving around the world so the consumer is in good shape and it looks like it’s willing to consume going forward.

HP: OK. Let’s discuss where the money is. Which regions have we seen with some of the highest savings levels accumulated and what could that really mean for some of those growth prospects in those regions?

JL: Well, obviously the saving ratio varies depending on which region you’re looking at. China continues to lead major economies when it comes to saving rates with households putting aside around 40 cents of every dollar they earn. And that hasn’t really changed a lot during the crisis.

On the other hand, we’ve seen significant increases in the eurozone and elsewhere in the world. In the eurozone households are now saving about 10 percentage points more which basically represents a doubling of their savings ratio. In the UK and in the US it’s a similar story but even more impressive with savings rates having gone from mid to high single digit to the mid-20s during the crisis.

So in terms of growth what does that mean?  Well, it means that clearly there is a lot of pent up demand and particularly in the UK and in the US those two regions or countries could see the highest boost should consumers decide to spend this excess saving.

HP: So we’ve spoken about savers, certainly a big opportunity there but what do you see as the risk that could disrupt a consumer led recovery?

JL: Well, there are a few risks for consumers. First is we may not actually see that consumer led recovery if consumers decide not to spend but instead they want to use this money to pay down debt or increase their safety net until the pandemic finishes or labour market conditions improve.

The other risk you have is that the outlook could deteriorate if current virus variants reduce vaccine efficacy rate, if the recovery starts to stall then consumer confidence could quickly deteriorate again and obviously in order to spend consumers need to feel like spending. And finally, there is also a question around inflation and whether prices will continue to rise as you mentioned earlier.

Although it’s not our view if that would be the case then purchasing power would drop and that would potentially hurt consumer sentiment and again willingness to spend. So there are a few risks on the horizon when it comes to whether the consumer will be the driver of the recovery.

HP: OK. Let’s go a little bit more practical. Which sectors are likely to benefit from the increase in household spending? Where are the best opportunities for investors?

JL: So when you’re trying to capitalise on this global consumers’ war chest the consumer discretionary sector is the logical first step. However, on a global basis this is a sector that has already doubled from its pre pandemic level.

So it’s important to know if it will be more selective going forward. When people were stuck at home they couldn’t spend on services and most of the spending was goods related. Now that we have economies reopening, international travel gradually resuming and consumers starting to spend more on services in this context travel and leisure, restaurants will appear to be well positioned to benefit.

On the goods side most of the growth is likely to be more on the apparel side as consumers feel the need to buy clothes again. Now when you look at the performance of some stocks in these sectors some of them remain well below their pre pandemic level and that could actually look like a good opportunity. However, we don’t think it’s necessarily as easy as that.

There is a reason that these stocks are still far from their recent highs. In fact, many of these companies have had to raise capital, either equity or debt, to survive over the past 12 months and as a result while their revenues and profit may recover relatively quickly once the economy is fully reopened the shift in the capital structure may justify lower valuations going forward.

And so in this context we believe investors need to proceed with extreme caution and avoid bottom fishing. So in the consumer discretionary space we remain most conservative on services providers with solid balance sheet.

Alternatively, investors could consider payment companies as they seem to be able to benefit irrespective really of where the money is being spent. And finally, in case consumers decide not to spend but rather to invest asset manager could benefit in our opinion.

HP: Well, thank you Julien for your insights today. We know growth prospects around the world are certainly reliant on a level of consumer spending. We’ll be watching the developments to see if they do indeed unleash those built up war chests in the coming weeks and months.

Let’s move on to consider the outlook for this week. Focus of course will be on the FOMC meeting.  Given the magnitude of the recovery in both growth and inflation it’s possible the FOMC may begin its discussion about whether to initiate tapering but the slower progress on employment suggests those discussions won’t really heat up until late summer.

We expect the Central Bank to reduce its rate of asset purchases at the beginning of next year which we’ve said before it’s only likely to occur in a targeted and controlled way to avoid any tantrums playing out. In the UK investors will await the labour market data on Tuesday. We’ll look for the unemployment rate to hold steady at 4.8%. Inflation figures are out in the UK on Wednesday. We expect CPI to print at 2% year on year.

We also get the release of May’s economic data from China on Wednesday where we look for retail sales to be up 13% year on year, industrial production up 9%, fixed asset investment up 17%.

With that, I’d like to thank you once again for joining us. We will of course be back next week with our latest instalment but for now may I wish you every success for the trading week ahead.