Markets Weekly podcast - 08 March 2021

Henk Potts (HP): Hello its Monday the 8th of 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. In 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 past week. I will then review the UK budget and the outlook for the UK economy. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

As we know, it was an intensely volatile week in global financial markets last week as investors questioned central banks commitment to keep historically low interest rates in place for a prolonged period of time as short term inflation expectations rise.

A perceived lack of concern from Fed Chair Jerome Powell did little to calm market nerves. If you look at equity performance last week, despite some heavy losses midweek, major benchmarks rose over the course of the trading week as positive economic data boosts confidence around the speed of the recovery.

In Europe the Stoxx 600 was up 0.9%. The S&P 500 was up 0.8%. In bond markets we've seen some pronounced movements in yields over the course of the past couple of weeks. 10-year Treasury yield hit 1.62% last week which is the highest since February 2020. Remember that's up from under 1% at the start of the year.

However, we don't think investors should be overly concerned. We’re not seeing evidence of persistent long term inflationary pressures build. Policymakers have continuously stated they will remain ultra-accommodative, even if economies temporarily run hot from an inflation perspective.

Central banks have plenty of tools to quell rising bond yields including more aggressive bond purchases and, of course if required, the introduction of yield control measures. We should also remember rising bond yields can equally be viewed as a consequence of the improving economic environment which would be positive for corporate prospects.

On the data front, the latest employment report in the US was released on Friday. The economy created more jobs than expected in February. Payrolls rose by 379,000, the market was looking for a figure closer to 200,000.

January's gain was upwardly revised to 166,000 as falling COVID cases and the easing of restrictions in many states is encouraging employers to hire back workers. The biggest gains were in the leisure and the hospitality sector.

The unemployment rate eased down to 6.2%, although there are still 10 million unemployed Americans, nearly double the pre-pandemic level. We do think momentum is in the labour market in the United States, unemployment rate will be down to 4% at the end of the year.

Confidence should also get a boost from the passing of the stimulus package. Over the weekend the Senate passed President Biden’s $1.9 trillion relief bill, that's the second largest in US history and expected to be confirmed in a House vote on Tuesday.

Key elements include direct cheques of $1400 sent to millions of Americans, unemployment benefits increased and extended into September, $350 billion to help schools re-open, support for state and local governments, $160 billion for Coronavirus testing and vaccine distribution programme.

In terms of the impact, the aid should temporarily supplement income and government spending while the economy is being weighed down by the pandemic. The speeding up of the vaccine roll out should reduce new cases, help to revive the service sector and assist in restoring employment prospects back to pre-pandemic levels.

There is real momentum in terms of the US economy as evidenced by recent data releases, show strength not only in the labour market that we've been talking about but if you look at things like retail sales, home sales, and equipment investment, it's all been very robust. If you look at estimates for growth for the first quarter they now sit above 4%.

We think full year growth will come in around 6.4%, significantly higher than its counterparts in the developed world.

In energy markets, crude prices have surged 10% over the course of the past five days. Brent trading at $67 a barrel at the end of last week after OPEC declined to hike production levels and rising above $70 a barrel at the start of this week after a drone attack on a Saudi export terminal over the course of the weekend.

That's taking the year to date gains to around 37%. The OPEC+ alliance surprised markets by agreeing not to increase production levels last month. The cartel was understood to be considering restoring as much as one and a half million barrels per day of production. Its demand expectations have been rising as economies reopen, inventory levels are projected to return to targeted levels, and prices have risen above the break-even point for many producers.

So after a year of agony, it appears some members still remain either cautious about the recovery in demand or are attempting to maintain restrictions to keep prices elevated. It was reportedly Saudi Arabia that managed to encourage other members to refrain from an increase, thereby creating this supply squeeze that would of course support prices in coming months.

If higher prices are sustained it would have implications for inflation and potentially infringe upon the economic recovery. However, there appears limited upside. Members such as Russia are unlikely to keep the taps turned down for an extended period of time if prices maintain their upward trajectory. Higher prices will also encourage US shale producers to come back on line. We think that Brent will average somewhere around about $62 a barrel during the course of this year.

So that was the global economy and financial markets last week. Let's move on to consider the outlook for the UK economy.

I’m pleased to be joined by Fabrice Montagne, he’s the Chief UK economist with Barclays Investment Bank. Fabrice the budget, of course, was the big headline grabber last week. For the Chancellor it felt like a balancing act as he tried to ensure the recovery but also offer a strategy for putting the public finances back onto a sustainable path. What was your take on the measures announced?

Fabrice Montagne (FM): Yes, good morning Henk, thank you for having me. Listen, I think it's fair to say we were surprised by the magnitude of the budget. I mean, we went into the budget, you know, basically focusing on whatever the press was reporting beforehand and that was tax hikes, right, and what we got is actually quite a powerful support package for this year with a lot of extensions in there.

Think about furlough scheme being extended not three months but six months, same holds for self-employment support, same holds for various support schemes for businesses, VAT cut as well extended by another pair of months for hospitality sector. So, a lot in there to ensure that the recovery remains on track this year and even more that the recovery is very confident and powerful and that is definitely something we like.

We liked, you know, the stance by the Bank of England for instance the MPC there was already pushing, you know, as much as they could and we now have the sense that the Treasury also takes this recovery very seriously, and especially takes seriously the risks of that recovery not happening because of a variety of reasons.

So, you know, the short term boost is clearly something we like. That leads us to revise our forecast up for this year and next year. We do carry over some of that momentum into the medium and the long run because along the way we will suffer less unemployment, less bankruptcies and that minimises, if you want, the amount of economic losses that you make along the way and minimises the amount of economic scarring that you'll end up having at the end of this recovery.

One point I didn't mention is the ‘super deduction’ so called for investments. So businesses will now be able to deduct from their taxable income more than the amount that they are investing which is quite a powerful scheme to incentivise businesses to go out and invest, if I may.

It is though a temporary scheme so don't expect that to lead to a permanent increase in investment in the economy but it is a powerful way to frontload, you know, investment that would otherwise have been smoothed maybe over many, many years but now you can front load much of that in the first two years of the recovery.

So, you know, all in all, fair enough we went into this this budget with very cautious expectations but even those of us, you know, who expected a bit more have been surprised on the upside, so I guess that’s the good news.

HP: So bearing that in mind, please can you share your current forecast for the UK economy.

What are going to be the key growth drivers and what are the main risks to your assumptions?

FM: Yeah, so it's fair to say that the recovery, I mean the recession was consumption driven because consumers and households had to rein in their spending because of, you know, lockdowns and virus prevalence and all sorts of measures that prevented people to engage normally, and by engage I mean spend.

So it is normal to expect the recovery to be driven by consumption and that's what we expect. Investment this time around is expected to play less of a role. It is expected to recover, don't get me wrong, but you know investment usually overreacts to the recession and to the recovery.

This time around we expect it to move more or less in sync with GDP. So it is truly a consumption led recovery and that's why we make a big deal out of the measures announced in the budget that support consumption.

We also make a big deal out of the improvement in public health. The vaccination programme allows, I mean vaccination programme together with lockdown measures, allows for caseloads to drop quite remarkably.

Also we are now seeing signs that hospital admissions are dropping really convincingly, so that means that the public health backdrop is now much better and much more supportive to recovery led by households. So the numbers we are talking about is something around 4.4% growth this year and much stronger next year, just short of 6% growth next year.

So there are some calendar effects here but what you have to picture is a very slow start of the year and actually a start of the year with a recession because we were still in a lockdown in the first quarter, but from there on quite a hefty recovery and, you know, growth rates per quarter that we have never seen in peacetime and I'm thinking about 4% quarter on quarter, where we usually discuss whether growth is 0.3 or 0.4 right. So, that's the kind of profile you have to expect.

It is though a recovery that we expect not to last forever obviously and it should ease out in the course of next year. And the reason for that is that despite, you know, having a lot of short term boost in the budget and short term boost elsewhere, you know, talk for instance about excess savings or these kind of things, we are missing the kind of long term drivers for higher growth levels, you know, think about into ‘23 and ‘24.

So on that front, you know, we were a little bit underwhelmed by the content in terms of investment, of public investment, in the budget. Even though we do have commitment to set up a UK Infrastructure Bank, it does fall short to replace all the funding we got previously from the European Investment Bank or the European Commission. So on the longer term picture we’re still facing a decent amount of structural headwinds that did not go away, you know, with this budget.

So, the shape of the recovery, Henk to your point, is quite a strong rebound in this year, think about quarter two, three, and four this year, and then a recovery that flattens out fairly quickly in the course of next year because we're missing these longer term growth drivers.

HP: I wanted to delve a little bit deeper into the concept of consumption. We know households have been able to save remarkable amounts. How is excess savings influencing your forecasts and as the UK economy reopens how much of this money will really be spent in the coming months?

FM: So that's the 125-billion-pound question Henk. That's the amount that has been saved, according to the Bank of England, up until November last year right. And with consumption expected to drop again in Q1 because of the lockdown, that number will only grow over time.

And we expect, you know, the order of magnitude that you have to have in mind in terms of excess savings, so it's truly the amount of saving on top of what households usually save on a quarterly or monthly basis. We expect that amount would be in the fashion of 10% of GDP. 10% of GDP: that's 200 billion, more or less, in the case for the UK. That's unprecedented in peacetime, right.

We usually see excess saving, that we usually don't call excess saving but precautionary saving, build up during recessions because that's a normal behaviour but never so fast and never so much, right.

So, we are truly in uncharted territory here, at least uncharted in peacetime, we see that in war times. But, you know, not sure that the comparison here would be 100% correct.

Now that leaves us with a huge risk, you know, over our forecast and this idea of whether or not excess savings will be spent is probably the biggest risk that we currently carry on our forecast. On the upside and the downside, by the way.

What we know, and that's true in the UK but also elsewhere, is that these savings are tilted, are held predominantly by more wealthy households. You know, we have all sorts of metrics able to support that that idea. And why that matters is that usually wealthier households who don't face budget constraints in normal times usually have a lower propensity to spend excess savings.

So what that means in short and simplifying, it means that that saving might actually not be spent. It might stay in various assets, investments: think about housing, think about financial investments, it might predominantly stay there, hence not contribute to supporting the recovery.

Obviously I'm simplifying, you know, this is not a definite answer and we do have endless internal and external discussions around this topic because obviously opinions differ widely, but I think we should prepare to be underwhelmed by the amount of excess saving that that will be spent.

Now the problem I have with that, is you realise that I struggled to answer your question with numbers Henk, because even if I'm wrong by a minimal percentage given the numbers we’re talking about it may have a bigger impact on the recovery.

So we have to be very cautious here, we have to acknowledge that we are facing unprecedented times with really high levels of uncertainty and both on the upside and the downside.

And excess saving here is clearly what is put forward by, for instance, if you try to assess the stance of the Bank of England, it's clearly those MPC members who are more hawkish, right, put forward this idea that more excess savings will be spent eventually than what others think, right. So here is the big uncertainty, and definitely, you know, we will talk about this amount of excess saving for many years.

HP: If we look at the Bank of England’s Monetary Policy Committee, they have become more optimistic, it feels, over the course of the past couple of months. It appears that negative rates are now off the cards.

Would you say that's correct, and should we now even be pricing in the possibility of a rate hike?

MF: Yeah so, the funny thing about that is, you know, a month/six weeks ago we were pushing back against negative rates expectations and now we're pushing back against interest hike expectation, right. It's crazy how quickly the market swings from one to the other.

I think, also, related to the point on uncertainty, it's fair to say that at the minute, also because we don't have reliable economic data, the only economic data we have refers to a period of lockdown where economic behaviours were just some of them outright forbidden, right, so we don't know how this economy can function once you have reopened.

And to have a view on that we need another three to six months of data, right. So whether to judge, I mean what I'm trying to say here, we're not in a position to judge whether the recovery is happening or not and we will only be in I think about six months’ time.

For sure, however, the budget has contributed to change the distribution of risks and, you know, there are probably much less downside risks today than there were a week ago because of action taken by the government.

And on that front, you know, we believe that the more dovish members of the MPC will likely be reassured of the latest round of fiscal easing. The main worry of those members was that if the recovery doesn't happen then we fall into a recessionary trap or low growth trap and in that circumstances policymakers may have to do more, right.

So, what those members were putting forward is that if you get into the situation where growth does not happen, the cost of pulling yourself out of this is much more than the cost of you getting it wrong on the other side.

However, the distribution of risk, I think, has changed, you know, possibly remove much of the pricing of negative rates. For sure, the MPC likes to have expectations upwards sloping because that's what they usually work with.

The MPC is structurally optimistic on the back end of the forecast, on year three they are always above actual numbers, so they always have this bias, you know, this optimistic bias if I may.

 So that's probably the situation that they will want to entertain going forward, but clearly, you know, over the summer and going into the second half of the year we will have a serious discussion based on actual data, you know, on whether the economy is doing well or not and whether or not, you know, the Bank of England and others need to do more to help or whether they are in a position to already discuss, you know, withdrawing some of that stimulus.

Don't forget there are also tax hikes in the budget right, we just talked about the giveaways, but there are also tax hikes. Corporate tax is about to increase from 19 to 25% over a couple of years.

We also have income tax which will increase because the government is about to freeze thresholds and allowances and we also have spending cuts in there. So over time, you know, the fiscal stance will turn from being accommodative in the first couple of years to being restrictive.

So that will also limit the scope, you know, for the Bank of England to be restrictive as well. So, I think, on that, you know to answer your question Henk, it's fine to play around with pricing because, you know, data comes and we revise our views but we won't be able to have a high confidence view on the future course of policies before the second half of this year I believe.

HP: Well Fabrice, thank you for your insights today on the budget and the outlook for the UK economy. It’s certainly set to be a fascinating time as we begin to emerge from the pandemic.

Moving on to the key events this week. Friday's UK January GDP estimate will give an indication of the economic performance during the first month of the lockdown. After growth of 1.2% month on month in December, we expect the impact of the third national lockdown to cause a significant contraction in January’s monthly GDP.

We expect most of the drop to be driven by consumption, reflecting the re-establishment of restrictions on non-essential retail, hospitality, and schools. Against a backdrop of suppressed economic activity, we do know inflation rates generally remain below central banks targeted levels. The US February year on year core consumer price index out on Wednesday will likely continue to show subdued momentum in inflation, which we expect to see throughout the first quarter.

The January reading of 1.4% year on year was held back by drops in services components and the continued weak shelter print. We expect to see a reading of 1.3% y/y for February given the underlying softness in services. Finishing off with China’s CPI. We know that's been muted with year on year contraction of 0.3% in January after weak growth of just 0.2% in December.

We think January’s year on year decline in CPI is temporary, largely caused by the timing of the Lunar New Year and expect more moderate inflation in 2021 as the winter COVID outbreak is brought under control and oil prices continue to accelerate.

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