Markets Weekly podcast - 15 March 2021

Henk Potts (HP): Hello its Monday the 15th March and welcome to the 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 with Barclays Private Bank. 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. I’ll then analyse the outlook for the oil price. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Markets were very much in risk-on mode for much of last week on expectations that a robust recovery and central bank support can placate concerns over the threat of inflation and rising yields.

Sentiment was helped by a lower than expected US inflation print, higher yield push back from the European Central Bank, and of course the enactment of President Biden's US$1.9 trillion relief bill.

It was a positive week, as I say, for equity markets. S&P 500 was up 2.6% led by a rally in financials and industrials as that rotation into valuation continued. In fact, the S&P 500 is now up 5% year to date.

European shares actually had their best week since November: Stoxx 600 was up 3.5%, is now within 2.5% of the record achieved last year. We did see a continuation of the selling in U.S. government bonds.

At the end of last week 10-year Treasury yields spiked once again hitting 1.64% - that's the highest since February 2020 compared to below 1% at the start of the year. If you look at the spread between the two-year and the 10-year yield, that’s at its widest since September 2015.

In terms of the US inflation data showed headline consumer prices rose 0.4% to 1.7% year on year in February but core inflation, which to remind you strips out the volatile food and energy components, rose just 0.1% on the previous month to 1.3% year on year.

In terms of the outlook: the stimulus fuelled recovery, pent up demand, and the normalisation of activity as the US achieves herd immunity by the end of the second quarter should certainly boost prices but the economy continues to have significant spare capacity compared to where we were at the start of the recession and aggressive rates of technology adoption should further help to alleviate inflationary pressures.

In terms of forecasts, we think inflation will remain subdued once we look through the positive second quarter base effects. We forecast the Fed's preferred measure of inflation, that's core PCE, at 2.2% in the second quarter, then easing back to 1.8% in the third quarter, 1.9% by the time we get through the fourth quarter and averaging just 1.8% through the course of 2022.

And to remind you, the Fed’s averaging inflation targeting framework gives the central bank the flexibility to let inflation run above the 2% target rate for an unspecified time and by an unspecified amount.

Moving on to the European Central Bank. As expected the ECB kept interest rates on hold and maintained the size of its bond buying programme but they did react to the rise in bond yields with President Lagarde warning the increase in sovereign yields could eventually translate into a tightening of financial conditions which the governing council deemed would be undesirable, given the still uncertain and depressed economic situation and the weak medium term inflation outlook.

In response the governing council expects bond purchases over the course of the next quarter to be conducted at a significantly higher pace than in the first month of the year.

So they're very much frontloading the purchases while keeping the size of the overall package unchanged at 1.85 trillion euros. European Central Bank did update its forecast.

It said growth profile would be broadly maintained with previous projections, with 2021 growth of 4% with a stronger second half of the year offsetting a weaker than expected start to the year.

To the near term downside risk is continuing, but the medium term has become far more balanced. Growth of 4.1% is projected for 2022, 2.1% for 2023. As expected, the inflation forecast was revised significantly higher for this year from 1% to 1.5%.

They stressed inflationary pressures for 2022 and 2023 remain very subdued at 1.2% and 1.4% respectively, still well below that 2% target level.

In terms of impact, well markets will watch sovereign yields and the pace of monthly purchases to determine what the European Central Bank believes the shape of the curve should be to deliver those favourable financing conditions.

The policy has been criticised due to its lack of clarity and its vulnerability to global economic conditions, market movement and external shocks.

Moving on to China where the National People's Congress has been taking place over the course of the past week. It’s where the Communist Party leadership unveils its key policy decisions and targets.

Key economic measures were laid out in the government work report. China set a growth target of more than 6% for this year. Authorities said they would provide targeted support for SME financing, mortgage loans for first time buyers, and funds for tech and the green sector.

In terms of inflation, the NPC set a target of 3% for 2021. For monetary policy, they said they adopt a prudent monetary policy with appropriate flexibility with greater priority to serving the real economy and preventing risk. In terms of the forecast, well growth estimate actually looks quite conservative.

We have growth rate of 8.4% pencilled in for this year given the low base and still strong growth momentum, of course we’ve seen evidence of that today with strong figures coming through from industrial output and retail sales in China against, it has to be said, a very low base but some impressive figures saying that V shaped recovery continues to play out.

In January, CPI fell into deflation but is expected to return to inflation and rise towards 3% by year end. We expect the People's Bank of China to keep policy rate unchanged in the first half but guide credit growth lower.

Faster urbanisation, we think, should underpin housing demand as well. So we think Chinese equities still look attractive. They’ve got solid long term growth prospects, relatively more attractive valuations, continued support from local authorities. Best way to gain exposure to that is very much through funds.

So that was the global economy and financial markets last week. After oil's incredible performance so far in Q1, the price of Brent this morning hovering around $69 a barrel, I’m pleased to be joined by investment strategist Jai Lakhani to discuss the key drivers behind the performance, consider the outlook for oil prices and how investors should position their portfolios.

So Jai, let's start off: what has been triggering the rally in oil so far this year? Tell us more about those key drivers behind the performance.

Jai Lakhani (JL): Sure, good morning Henk, thank you for having me. It’s the question on everyone's mind really and the rally is quite remarkable with oil up around 34% year to date.

To answer the question, we need to remember that the price of the lubricant will always reflect three key components: demand, supply, and inventories.

So what has affected demand? Well, the market always priced in a recovery for 2021 because of vaccine expectations but the speed of the distribution has been impressive and, more importantly, it has been backed by fiscal stimulus - we have the examples of the UK and US.

We've also at the same time had a weaker dollar.

What has affected supply and the inventory side? We've had a lot more increased regulation on the sector, weaker investment levels, and OPEC+ (Organisation of the Petroleum Exporting Countries) surprising expectations of a 1.5 million barrels per day hike by committing to a tighter oil market and keeping cuts in place for April.

Not only have cuts been kept in place, but Saudi Arabia have made it clear that the cuts are here to stay and will be phased into the market over time even when it does come back into the market.

HP: So what are the fundamentals for oil are looking like you as you go forward? Can we see much further upside from here or could we indeed be thinking about a market correction?

JL: I think it's fair to say with more conviction that the worst is behind us with regards to the pandemic's impact.

The strong demand from the recovery, OPEC+ keeping production cuts in place, and increased regulation all indicate price rises.

If we look at the International Energy Agency, they forecast world oil demand is set to grow by 5.4 million barrels per day in 2021, recovering around 60% of the volume lost to the pandemic in 2020.

Today the only real risk to the rising oil price that I see is COVID mutations that are immune to the vaccine. If this happens we could see demand fall in a similar way to last year.

I, for one, don't want this scenario to unfold and I'm sure I'm not the only one craving a holiday abroad this year. If we avoid this scenario and travel restrictions ease later on in the year, demand for oil from transport could also stage a comeback.

So we have the floor, but the next question would be how significant is the upside. Thinking about the impact higher oil prices has on inflation, it has the potential to really impact the recovery.

Already we will see pressures as a result of base effects and demand could be tapered as result of much higher prices.

You also have to think about it from a supply side: higher prices provides incentives. OPEC+ do have their agreement in place, but higher prices from here could mean countries like Russia break away and increase production.

There is also the likelihood of outside the bloc US shale producers coming back online. Also, when we look at OPEC inventories, they could become stretched with the current cuts.

Some estimates anticipate a 1.8 million barrels per day deficit in the next three months, which could bring OPEC inventories back to the 2015-2019 averages by June.

Overall, to paint the picture, we remain constructive on prices this year, with a $62 per barrel and $58 per barrel price forecast for Brent crude and WTI respectively.

HP: So given that constructive view that you have on oil, how do you think investors should be prepared in order to capitalise on those conditions?

JL: Well Henk, I think the one liner to this answer is prepare for inflationary pressures. On the equity side, of course, oil producers and countries/indexes exposed to oil will likely benefit.

I’m specifically thinking of emerging market in Brazil and Latin America on the FTSE 100. However, going further than this, under inflationary periods you really want companies with pricing power so they can pass these costs on.

So you have your luxury companies that will also benefit from the economic recovery as consumers come back and unlock the pent up demand. It is also worth considering chemical companies. They can add a lot of value in the manufacturing process and thus command price increases.

From a fixed income point of view, higher oil prices supports the credit quality for some emerging market issuers, specifically oil producers, but overall issuer specifications and pricing is something investors will probably need to take a closer look at.

HP: Well, thank you Jai for your insights today. We know energy prices are certainly a key cost to businesses and consumers as well as having broad ramifications for inflation, as you mentioned, and asset price performance, something we will continue to monitor very closely over the course of the next few weeks and months.

Moving on to the key events for this week. Wednesday's Federal Reserve meeting and Thursday's Bank of England Monetary Policy Committee meeting are likely to grab investors’ attention.

We do not expect any significant changes to Fed policy with central banks expected to acknowledge the improving health situation and the increase in fiscal support.

The focus will very much be on any communication surrounding the threat of inflation, the impact of higher yields, and possible toolkit to mitigate those risks. Lack of comment could certainly create further nervousness in markets.

The MPC are expected to maintain its accommodative stance while waiting to see how the recovery evolves. Investors will also focus on retail sales numbers coming through from the United States.

To remind you, US retail sales jumped 5.3% month on month in January following three months of declines, significantly outperforming market expectations. The rebound was fairly broad based across categories, though there was a tilt towards discretionary spending.

The January boost in retail sales was strongly correlated with the additional fiscal support to household income with the late December stimulus, therefore the market expects a small decline of 0.4% month on month in Tuesday's February numbers.

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