Global equities recorded further gains ahead of the US consumer inflation data
Equities recorded further gains in the past week, with investors taking a more constructive view regarding the outlook on inflation. Emerging market equities overperformed their Developed market counterparts, albeit the valuation gap year-to-date (-6%) remains wide.
Government bond interest rates in core markets declined modestly, as the US labor market report was unexciting. The 10-Year US Treasury yield declined by 3 basis points to 1.55% and the 10-Year Bund yield fell by 3 basis points to -0.19%. Euro area periphery bonds remain well bid, with the GGB/Bund spread narrowing intra-week to 99 basis points, its lowest level since October 2008.
US job creation was slightly below consensus expectations in May, with non-farm payrolls (NFPs) increasing by +559k, compared with +278k in April. The unemployment rate fell by 0.3 pps to 5.8%. The ongoing jobs shortfall of circa 7 million relative to pre-Covid levels suggests that the labor market still has a substantial amount of slack.
Sustained improvement in the labor market is a prerequisite for the Federal Reserve to start tapering its large-scale asset purchases of US Treasuries and agency MBSs. Nevertheless, the “discussion about discussing” QE tapering could commence at the June 16th meeting.
The Federal Reserve will begin gradual sales of its holdings (circa $9bn) of corporate bond ETFs on June 7th, winding down the portfolio of the temporary (which closed on December 2020), Secondary Market Corporate Credit Facility (SMCCF). The Fed intends to begin gradual sales of its corporate bond holdings (circa $5bn) this summer.
The SMCCF and the Primary Market Corporate Credit Facility (no transactions occurred under the PMCCF), established on March 2020 to support credit to employers, by providing liquidity to the corporate bond market.
Note that the size of the SMCCF and the PMMCCF was up to $750bn, suggesting high effectiveness of the signaling channel of monetary policy. Indeed, both USD Investment Grade and Speculative Grade corporate bond spreads have narrowed significantly, hovering close to their cycle tights of circa 90 and 328 basis points, respectively.
Attention turns on June 10th, to the US CPI announcement for May. The headline and the core annual growth are expected to accelerate to +4.6% (+4.2% yoy in April) and +3.3% (+3% yoy) according to Federal Reserve Bank of Cleveland Inflation Nowcasting model due to (i) favorable base effects intensifying (albeit also peaking), (ii) pandemic-hit items normalizing further and (iii) with transitory upward effects due to supply chain bottlenecks, remaining in place.
The European Central Bank on June 10th is expected to stand pat regarding the pace of PEPP purchases (€20bn/week), as recent guidance (Lagarde, Lane) was clear in that regard. The accompanying quarterly macro economic projections, will also be monitored, as risks to the economic outlook are becoming more balanced due to vaccinations. The inflation outlook will remain subdued (CPI 2023: 1.4% to 1.5%).