Synchronisation delayed

The narrative for 2021 was to be a global economy that became increasingly synchronised over the course of the year. The higher vaccination rates in Europe and the U.S. were to lead to economies re-opening and joining in on the positive momentum by those, mainly Asian, economies which had done a better job in containing the spread of COVID-19. However, the spike in virus numbers across Asia and the renewed restrictions on mobility are creating delays to this virtuous path towards synchronised global growth.

The pick-up in case counts in some parts of the world and the ongoing inflation worries were largely offset by economic data that pointed to stronger economic activity. Developed market (DM) equities rose 1.5% over the month and emerging market (EM) equities were up 2.3%. This was the first month that EM equities outperformed DM equities since January. Movements in bond yields were relatively contained as the Australian 10-year government bond fell 6bps to 1.63% and the U.S. 10-year a similar amount to 1.58%. The move in the nominal yield masks the movement below the surface as inflation expectations continue to rise and real yields fall.

Inflation remains the key focus on the macro front, notably in the U.S., given the spike in the April reading and the growing view that tight supply chains, semiconductor shortages, higher commodity prices and falling unemployment rates could mean inflation proves to be stickier than some central banks currently believe. The inflation risk is perhaps strongest in the U.S. labour market, which is disrupted by supplementary unemployment benefits and expectations of further fiscal stimulus. The core reading of inflation in the U.S. surged by 0.9% month-over-month (m/m) in April, the largest monthly gain since 1981. Meanwhile, in Australia, inflation readings remain subdued and the core rate of inflation was only just over 1% and wage growth was at an unexciting rate of 1.4% year-over-year (y/y).

Rising input prices may start to pressure margins and more companies have highlighted the risks around being able to source raw materials or appropriately skilled labour. Pricing power of companies should be monitored closely when assessing the still very positive earnings outlook globally.

Vaccination rates and inflation will continue to dominate the market view in the near term, however, as we head towards the middle of the year, prospects for growth remain bright. Investors may become more discerning in country allocations as vaccination rates vary across the globe and they assess the possibility for monetary policy divergence on this basis. 

Economy:

• Australia’s April employment report was the first look at employment trends following the expiration of the JobKeeper program. The unemployment report fell to 5.5%. The number of people employed fell by 30,000 in the month but was offset by a sharp drop in the participation rate, resulting in a fall in the overall unemployment rate. The labour market continues to improve faster than expected, but viral cases in Victoria and the end of benefits may see the pace of improvement slow.
  (GTM AUS P. 8)
• Consumer sentiment dipped in April as it came off a decade-high. However, the consumer response has been very strong given the release of pent-up demand that continues to filter into the economy. Preliminary retail sales surged in April compared to a year ago, up more than 25% y/y.
  (GTM AUS P. 5)
• The housing market is being distorted by public policy. Building approvals fell 10% m/m in April after two prior months of around 20% gains. House prices continue to rise and the eight capital city index rose 1.8% over May and 6.4% on a year ago. However, increased investor activity is gaining the attention of the Reserve Bank of Australia and regulators and the expectation is that macro-prudential rules will be imposed.
  (GTM AUS P. 10, 11)
• The Commonwealth 2022 Budget maintained the path for fiscal repair, but with enough cyclical improvement to fund already-announced measures. The underlying deficit for the 2021 fiscal year improved by AUD 37billion to AUD 161billion. While the policy should add to the fiscal impulse in the economy, compared to what was delivered in 2020, they will be much lower.
• Purchasing Managers’ Indices (PMIs) in the U.S. beat expectations in May and rose to the highest level on record, suggesting that there is still more growth to come. However, the Federal Reserve is also watching that stronger growth and making noises about potentially tapering the current run rate of bond purchases.
  (GTM AUS P. 16)
• China manufacturing PMI rose very modestly in May to 52.0. This is the highest reading of the year for this forward-looking indicator. However, Chinese policy makers continue to limit credit growth in pockets of the economy to increase financial stability and shift to more normal policy settings. 

Equities:

• The ASX 200 rose 2.3% in April, outperforming most global equity markets, except Europe (2.5%). EM equities gained 1.4%, DM equities by 1.1%. The cyclical/value rotation was stronger in May as financials gained 4.4%, consumer discretionary 3.4% and materials 1.6%. The growth sectors of IT (-9.9%) and utilities (-7.0%) suffered large pullbacks. Meanwhile, large-cap outperformed small-cap stocks in Australia.
• U.S. 1Q corporate earnings were much stronger than expected. S&P 500 companies reported earnings growth of 47% y/y relative to consensus expectations of 20%. However, despite the strong earnings performance, the S&P 500 rose 0.7% in May, as the more expensive technology and consumer discretionary sector, which accounts for 40% of the index, came under pressure.
  (GTM AUS P. 33)

Fixed income:

• The yield on U.S. 10-year government bond fell 5bps to 1.58% by the end of May, and the Australian 10-year yield fell by a similar amount to 1.63%. Nominal bond yields have largely moved sideways since March of this year. The uncertainty surrounding the inflation outlook and the monetary policy response has kept bond yields trading within a rather narrow band. Below the surface, inflation expectations have continued to rise and real yields fall, a dynamic not seen since the 2013 taper tantrum.
• Credit spreads widened slightly over the month but spreads on higher quality investment grade bonds remain near their narrowest points. Emerging market debt offers a higher yield but remains a very selective asset class given the cloud that COVID-19 has cast over many emerging economies.
  (GTM AUS P. 56)   
  

Currencies and commodities:

• Gold rose by 7.8% m/m, suggesting that the persistent negative real yields has finally gotten markets’ attention in sensitive assets like gold and silver.
  (GTM AUS P. 68)
• The price of Brent crude headed towards USD 70 per barrel over the month. Increasing demand and supply that is being held back is helping the oil price stabilize around its current level. Inventory levels have been falling in the U.S., which is also helping. The potential for sanctions being lifted against Iran could see more oil flow into the global supply, which may create downward price pressure, but Organization of the Petroleum Exporting Countries nations and its allies may adjust their own supply to compensate.
  (GTM AUS P. 66)
• For all the talk of stronger Australian dollar this year, the currency has been flat over the first five months of the year, gaining only 0.2% against the U.S. dollar. The U.S. dollar was down for a second consecutive month and the DXY Dollar Index fell 1.3%. The economic re-opening in Europe is fueling sentiment towards the region and the euro gained 1.6% against the greenback.
  (GTM AUS P. 71)

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