By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Fed Chair Jerome Powell suggesting the US economy is at an “inflection point”, squaring with the IMF’s view of a US-led (divergent) global recovery (with 2021 US GDP growth revised up 3.3%-pts to 6.4%) appears to validate the record rallies on Wall St.
Dow is at a fresh record above 33,800; S&P500 at all time highs just below 4,130; although Nasdaq’s surge to 13,900 is shy of recent (Feb) highs near 14,100. But equity market euphoria is not limited to the US, as Euro Stoxx also printed record highs fractionally off 4,000.
Reasons for European equity market euphoria is admittedly less obvious than that for US. But an inflection in vaccine projections relative to subsequent wave of Covid infections helping to underscore activity recovery in Europe. Specifically, vaccine rollout plans in Europe, after earlier disappointments, looks set to be getting back on track.
But to the IMF’s point, the trouble is that inflection is an unevenly distributed luxury.
Europe’s catch-up with the the US in terms of vaccination progress only manages to dial back cross-Atlantic divergence to some extent; whereas the larger and more entrenched divergence between rich and poor economies remains unaddressed, if not exacerbated.
While markets may not quite fret the divergent global economy quite so acutely, rich Wall St valuations and may prompt worries of an inflection down from this bullish phase.
In FX land, the defining question remains. Whether the USD’s upturn since March is in fact a lasting inflection higher or a fleeting bounce set to resume the downtrend.
EUR building on traction from 1.17 lows in late-March back to 1.19 only adds to the confusion; as does AUD, despite bouncing off 0.75 lows. EUR is well off 1.23 levels at start 2021 while AUD is struggling to move up from 0.76 to 0.77 is a far cry far cry from 80 cents test in Feb. Especially as USD/JPY is elevated close to 110 is closer to recent highs testing mid-110.
USD/SGD at 1.34 is smack between its 6-mth 1.32-1.36 range; underscoring the lack of clarity. As mentioned before, conviction about, and durability of, USD inflection higher may hinge on the path of real UST yields, driven by the interaction of nominal yields and inflation.
… & Inflation
Speaking of which, signs of rising pipeline inflationary pressures are becoming prevalent; if the overshoot in PPI gauges for US, Japan and China are anything to go by. To be sure, one must be are wary of reading too much into rising factory gate prices. Especially at this stage of the global economic emergence from a pandemic, as capacity constraints in both production and logistics accentuate, if not possibly exaggerate, the underlying build-up in durable inflationary pressures.
That said, there is no denying that the threat of inflation unleashed by extraordinary and unprecedented reflation (led by US monetary and fiscal stimulus) will not be dismissed either.
The resultant surge in UST yields and commodity prices filtering through are bound to have far-reaching impact via lighter footed capital flows as well as current account dynamics. What’s more, this will cast a harsher differentiation in credit risk profiling; especially as the focus shifts from surviving pandemic to paying for it in the transition to the “other side”.
And EM currencies will be caught in the cross-fire between inflation and yield-seeking behaviour in a higher debt world paradoxically inundated with cheap capital. This is perhaps a point to be read between the lines of the IMF’s worries of a divergent recovery. And certainly a warning for overdone optimism about aggregated inflection.
On the aside, it is worth noting that the PBoC’s concern is about property bubble risks (asset inflation), and not factory gate cost pressures (demand inflection ahead of capacity).
Source: Mizuho Bank Ltd