Covid’s resurgence Has begun to detract from Asia’s second spring

It seems the global economic rebound is starting to falter.  At least, that is what one might conclude from the run of data we are seeing from virtually every nation, as well as the signals we are starting to get from the global central banking community.  For instance, on the data front, this morning’s UK numbers showed that growth, while still quite positive, is not quite living up to expectations.  May’s GDP reading was 0.8%, a very good number (it would annualize to nearly 10% GDP growth) but far below analysts forecasts of 1.5%.  Similarly, IP also printed at 0.8%, again well above last month’s data but falling far short of the 1.4% expectations.  The point is that economists’ views of the reopening burst seem to have been a bit overexuberant.  The UK is hardly alone in this situation with Italy also showing disappointing IP data for May (-1.5% vs. +0.3% expected).  And we saw the same thing from both Germany and France earlier this month.  In a nutshell, it appears that the European economy, while certainly growing more robustly than Q1, may well have seen its best days.

Meanwhile, in Asia, the delta variant of Covid-19 has become a much larger problem, with Japan, South Korea, Indonesia and Thailand particularly hard hit.  You have probably heard that the Olympics will be spectatorless this year in Tokyo as the Suga government has implemented yet another emergency lockdown order that is not due to expire until the end of August.  In South Korea, infections are rising as well and the government has increased curbs on gatherings of more than 5 people, while Thailand has once again closed ‘non-essential’ businesses to prevent the spread of the disease.  Vaccination rates throughout Asia have been much lower than elsewhere, with most of Europe and the US having seen between 40% and 50% of the population vaccinated while Asian countries are in the 5% – 10% range.  The issue is that while the virus continues to spread, economic activity will continue to be impaired and that means that markets in those economies are going to feel the pain, as likely will their currencies.

Of course, the US has not been immune from this run of disappointing data as virtually every reading in the past month has failed to meet expectations.  Two broader indicators of this slowdown are the Atlanta Fed’s GDPNow number, which is currently at 7.78%, obviously a strong number, but down from 13.71% two month’s ago.  As well, the Citi Economic Surprise index has fallen from 270 a year ago to essentially 0.0 today.  This measures actual data vs. median expectations and is indicative of the fact that data continues to miss its targets in the US as well as throughout the rest of the world.

Arguably, it is this downturn in economic activity that has been the key driving force in the bond market’s remarkable rally for the past two months, although this morning, it appears that some profit taking is underway as Treasury yields have backed up 4.8bps.  Keep in mind, though, that yields had fallen more than 25bps at their lowest yesterday in just the past two weeks, so a reprieve is no real surprise.  

The question at hand has become, is this just a pause in activity, or have we already seen the peak and now that fiscal stimulus is behind us, growth is going to revert to its pre-pandemic trend, or worse?  My sense is the latter is more likely and given the extraordinary amount of debt that was issued during the past year, the growth trend is likely to be even worse than before the pandemic.  However, slowing growth is not necessarily going to be the death knell for inflation by any means.  Lack of investment and shortages of key inputs will continue to pressure prices higher, as will the demand from consumers who remain flush with cash.  The worst possible outcome, stagflation, remains entirely realistic as an outcome.

And on that cheery note, let’s survey markets quickly.  While yesterday was a clear risk-off session, this morning it is just the opposite, with equity markets rebounding and bonds under some pressure.  While the Nikkei (-0.6%) failed to rebound, we did see the Hang Seng (+0.7%) pick up some while Shanghai (0.0%) was flat.  The big news in China was the PBOC reduced the RRR for banks by 0.5%, to be implemented next week.  Remember, the Chinese continue to try to fight the blowing up of bubbles in markets, both financial and real estate, but are looking for ways to loosen policy.  Remember, too, that inflation in China remains quite high, at least at the factory gate, with PPI released last night at 8.8% Y/Y.  This reading was exactly as forecast and a touch lower than last month’s reading.  But it is still 8.8%!  If this starts to trend lower over the coming months, that will be a strong signal regarding global inflationary concerns, but we will have to wait to see.

European markets, though, are uniformly stronger, led by the CAC (+1.75%) although the DAX (+0.9%) and FTSE 100 (+0.7%) are both doing well this morning despite the weaker data.  It appears that investors remain comforted by the ECB’s continued commitment to supporting the economy and their commitment to not withdraw that support if inflation readings start to tick higher.  As to US futures, while the NASDAQ is unchanged at this hour, both SPX and DOW futures are higher by around 0.5%.

It is not only Treasuries that are selling off, but we are seeing weakness in Gilts (+3.8bps), Bunds (+1.1bps) and OATs +0.5bps) as well.  After all, every bond market rallied over the past weeks, so profit-taking is widespread.

On the commodity front, oil continues to trade in a hugely volatile manner, currently higher by 1.15% after rebounding more than 3% from its lows yesterday.  Base metals are also moving higher (Cu +1.7%, Al +0.6%, Sn +0.1%) although gold (-0.2%) continues to range trade around the $1800/oz level.

As to currencies, the picture is mixed with commodity currencies strong this morning alongside the commodity rally (NOK +0.8%, AUD +0.55%, NZD +0.3%) while the yen (-0.3%) is giving up some of yesterday’s haven related gains.  EMG currencies are behaving in a similar manner with RUB (+0.75%), ZAR (+0.6%) and MXN (+0.3%) all benefitting from higher commodity prices.  However, we are also seeing HUF (+0.85%) rise sharply as inflation surprised to the high side at 5.3% Y/Y and encouraged traders to bet on tighter monetary policy given its resurgence.  On the downside, the Asian bloc suffered the most (PHP -0.4%, THB -0.4%, KRW -0.3%) as traders sold on the negative Covid news.

There is no data today nor any Fed speakers.  That means that FX markets will be looking to equities and bonds for it’s cues, with equity markets seeming to have the stronger relationship right now.  The bond/dollar correlation seems to have broken down lately.    While the dollar is soft at this time, I see no reason for a major sell-off in any way.  As it is a summer Friday, I would look for a relatively quiet session with a drift lower in the dollar as long as risk assets perform well.

Good luck, good weekend and stay safe

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