Three things to watch in the week ahead

Find out why oil may overshoot and why the euro could be in for a steep decline

It was a gutsy end to the week, US payrolls surged to 379k last month, a surprisingly large number that was led by the job gains in the food and service sector, i.e., restaurants and bars. As the US opens up, Texas has reopened its economy even though it has one of the lowest vaccination rates in any of the states in the US, jobs are coming thick and fast. The jobs data suggests that the US bond market was right to sell bonds, pushing up bond yields to their highest level in a year. The US is not out of the woods, it has still lost 10mn jobs during this pandemic, so job growth will need to remain consistent for the economy to recover fully, but it is moving in the right direction and there could be further to go. This leads us to the first event that we will be looking at closely this week: inflation. 

 

1. Price rises, and falls 

On Wednesday, both the US and China will release their latest inflation data. In the US, annual headline inflation is expected to rise to 1.7% in February from 1.4% in January. Headline inflation fell to 0.3% in May last year, its nadir caused by the coronavirus pandemic, thus a 1.7% rate 9 months later is a fairly big jump. The US Federal Reserve is willing to look through rising prices and has said that it will tolerate inflation above its 2% target rate for some time to make up for the economic harm caused by the pandemic. However, just how long will it be willing to do so, particularly if more states’ follow Texas’ lead and fully open up their economies even before their citizens have reached herd immunity from the coronavirus through vaccination, remains up for debate.  This contrasts starkly with Europe’s tough coronavirus lockdowns, and its lacklustre vaccine rollout. Time will tell if Texas is being reckless or if Europe is too cautious, from an economic perspective, the US is likely to out-perform Europe for some time. On the stock market front we are more cautious. The data right now suggests that the Fed will be tightening much earlier than the ECB and could tighten or adjust policy before the end of this year, particularly if we see consecutive upside surprises to the employment data. This could be bad news for tech stocks, which are sensitive to the rise in interest rates. Interestingly, the Nasdaq Composite shrugged off the better-than-expected NFP data and rose 1.5% on Friday. However, in time we think that fears about inflation and rising yields, the 10-year Treasury yield rose above 1.6% on Friday, although it closed the week at 1.56%, will start to erode confidence in US stocks. When this happens, it could spell good news for UK stocks, and we expect the Deliveroo IPO later this year to be a bellwether for demand for UK-listed stocks. Other stocks that could benefit from an inflationary environment include Vodafone, due to its decent 6% dividend yield, and Next, due to its large online presence and the rush of consumer activity that we expect once the UK economy starts to open up again from the end of this month. Thus, the long-awaited catch up for the FTSE 100 could take place this year, and Q2 could see a period of outperformance for the UK stock index. 

China’s consumer prices are expected to fall further into negative territory for February. The stark contrast with the US is down to two factors, firstly, the sharp decline in pork prices in recent months, and secondly the fact that China is at a very different stage in the economic cycle to the US and Europe. Its central bank has been tightening to ward off asset price bubbles and to reign in lending. This has started to bite, and it will be worth watching to see if the PBOC thinks that it is time to loosen the monetary taps in order to push inflation back into positive territory. The inflation data is released on the penultimate night of the National Peoples’ Congress, so if China’s rulers want to end on a high then they could always cut interest rates, which would be good news for commodities and the Aussie dollar. 

 

2. The ECB 

It’s hard to be positive about the EUR right now, and at the end of last week EUR/USD slumped in response to the stronger US NFP data. Rising yield differentials between the US and Europe are not helping the euro’s performance, and we expect this to weigh on the single currency for the long term. EUR/USD is below $1.20 and has fallen through key support at $1.1950. This opens the way to a long term decline back to November 2020 lows at $1.16. We do not expect the ECB, when it meets this week, to boost the euro’s prospects. The ECB is expected to reinforce the support that it is willing to provide to the euro area, we also expect to hear on Monday that ECB bond purchases have picked up again to more than EUR 20bn per week, after falling at the end of February. We expect Christine Lagarde to step up her rhetoric concerning the rise in Eurozone bond yields, in line with US yields. Although we do anticipate that a continuation of rising yields in the US will eventually see investors slow down their selling of European bonds, for now it is a problem. Unlike the US, Europe is back in recession, a confirmation of the Eurozone’s negative growth rate for Q4 is expected this week, so rising bond yields are more dangerous for the EU right now than they are for the US. While we don’t expect the ECB to unleash the “whatever it takes” rhetoric of Mario Draghi, any concern about rising bond yields will likely be manifested in a weaker euro. 

 

3. The oil price 

Brent crude oil is a whisker below $70 per barrel at the time of writing, and we expect this key resistance level to be breached at the start of a new week. It is worth remembering that oil usually overshoots – either to the downside, as it did a year ago, or to the upside – so beware of any pullbacks. However, upward momentum, combined with strong US economic data, the end of lockdowns in the UK and the potential for a rate cut in China could all put upward pressure on the oil price and on commodities in general, in particular copper. The rise in the oil price is benefitting oil shares such as BP, its share price is up 25% in the past month. While we expect more gains for BP, ultimately the uptrend may not last for two reasons: firstly, its dividend is fixed, which is not good in an inflationary environment and may put some people off, secondly, BP has spoken extensively about its shift to renewables just as the oil price is surging; it remains to be seen if renewables will bring in as much revenue as fossil fuels. 

Overall, it’s another action-packed week for financial markets. Now that US jobs growth seems to have its mojo back, we expect the focus on economic data to remain intense. If US 10-year Treasury yields breach the critical 1.6% level then we would expect some volatility in stock markets, particularly the Nasdaq.