Running hot – but not too hot?

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Last year, the big themes that found favour in the market were the digital winners from lockdown and the potential green winners from Build Back Better. This year, there is more emphasis on the shorter-term winners from recovery.

The speed and nature of that recovery is now at the heart of the market debates. Will there continue to be good progress eliminating the virus and vaccinating the many?  Will “running hot” work, or could there be premature worries about inflation and too early a withdrawal of stimulus?

The US seems keen to reassure that it will get on top of the pandemic soon, and it will continue with both a large monetary and fiscal stimulus to ensure a great recovery. On Thursday, Jerome Powell reconfirmed the Fed stance. It is going to keep rates down and carry on buying bonds. It does not agree with the inflation fears or with those who advise them to set out a path to higher rates.

Virus battle continues

The numbers seem to show that cases of the virus, daily deaths and hospital cases all peaked in the US in the second week of January. There are still some hotspots, and the level remains worrying. The US is now towards the top of the global table for cases, with 8.9% of the population known to have caught it so far. It is edging up the death rate table to 1,600 per million.

President Biden this week strengthened his calls for people to observe all the rules, wear their masks and observe social distancing. He also had some tough words for any Republican state which is taking a more relaxed view of the situation.

The President wants to keep the pressure up against the virus to reinforce his view that it needs to be taken seriously. He is pushing hard to speed up the vaccination programme and expects to have offered vaccines to all adults by the end of May. This allows for the earlier vaccination of the most vulnerable, which should bring the death rate down more quickly.

Mr Biden is also pressing ahead with his large Covid-19 stimulus programme. It passed the House easily with the Democrat majority but is encountering some resistance in the Senate from Republicans. To get it through on a simple majority, the Democrats have agreed to remove non-spending matters like the minimum wage from the legislation – and have needed to cut the total sum below $1.9tn.

They are scaling back eligibility for the $1,400-a-person cheques, removing them from higher earners, and discussing how long they continue with the special pandemic unemployment payments.

Markets worry about inflation

It is the combined magnitude of the proposed fiscal stimulus and the extent of the monetary interventions that is worrying some in the markets.

They think it means the US will run too hot which will result in consequences in a range of other global markets as demand rises for commodities and energy. Mr Powell tried words to soothe them, which did not reassure enough. He may need to take actions to boss the markets more. They need showing they can lose money betting against Treasuries otherwise rates will drift up too far.

Mr Powell clearly has in mind something more like the Japanese model, where the state can carry on spending and borrowing safe in the knowledge that ten-year interest rates, as well as short rates, will remain anchored at very low levels.

The leading central banks and governments remain of the view that inflation will not get out of control, and that there is more risk to the downside than to the upside in economies. Markets are more impressed by the magnitude of the proposed US stimulus.

China targets 6%

Meanwhile, China continues with its very different economic model. The Chinese Peoples’ Political Consultative Conference will welcome a target of growth over 6%, in line with the pre-Covid-19 range. The economy may well outperform the minimum implied by this target, in what is the 100th anniversary year of Communist rule. The conference was also told that Hong Kong in future will elect people to the Legislative Council who are patriots, willing to go with the flow of China’s policies.

None of this makes US Chinese relations any easier and implies continuing frictions between the two major economies of the world. China will be critical of the US money-soaked recovery. The US will be critical of China on several counts.

Mr Powell needs to find ways to influence the markets soon to preserve the grand strategy of the new administration, based on a bigger boost to growth. We assume he will. His concern is not with sharp falls in any particularly overextended share or sector, but in keeping financial conditions loose enough to power a strong recovery with plenty of credit for consumers and businesses. Too big a rise in bond yields would tighten conditions in ways he needs to reverse.


View Article – published by Charles Stanley on 5th March 2021