Setting Up For A More Volatile Q4

After a disappointing September for risk assets, markets at least found some relief at the end of last week, with the S&P 500 ending up over a 1% while US Treasury yields fell and the US dollar also lost ground.  However, sentiment in Asia to kick of the week has been poor, with Evergrande concerns coming back to the forefront.

There was positive news on the US data front, with the Institute of Supply Management (ISM) manufacturing index surprising to the upside in September, rising modestly to 61.1 from an already strong level at 59.9 in August (consensus: 59.5) though the details were less positive.  In particular, the rise in supplier delivery times and prices paid reflects a re-emergence of supply chain issues. 

Separately, the infrastructure can was kicked down the road as infighting within the Democratic party on the passage of the bipartisan $1.2 trillion infrastructure bill and larger $3.5tn package, led to a further delay of up to one more month. It is likely that the eventual size of the proposed $3.5tn spending plan will end up being smaller, but there still seems to be some distance between the progressives in the Democratic party want and what the moderates want. Separately, the debt ceiling issue is likely to go down to the wire too.

China’s Evergrande remains in focus, with the company reportedly suspended from trading in Hong Kong pending “information on a major transaction”. According to China’s Cailian news platform another developer plans to acquire a 51% stake in the property services unit. The sale is likely a further step towards restructuring the entity and preventing a wider contagion to China’s property sector and economy.

Over the rest of the week attention will turn to the US September jobs report, which will as usual likely be closely eyed by Federal Reserve policymakers.   A pickup in hiring relative to the 235,000 rise in August is expected, with the consensus looking for a 470,000 increase. It would likely take a very poor outcome to derail the Federal Reserve’s tapering plans in my view.  

Several central banks including in Australia (Tue), New Zealand (Wed), Poland (Wed) and India (Fri) will deliberate on policy.  Among these the most eventful will likely be the RBNZ, with a 25 basis points rate hike likely while the others are all set to remain on hold.  Other data includes the European Central bank (ECB) meeting accounts of the September meeting (Thu), US ISM Sep services index (Tue) and Turkey September CPI (today). 

Overall, going into the fourth quarter investors will have to contend with host of concerns including weakening global activity especially in the US and China, supply chain pressures, persistent inflation risks, Evergrande contagion and related China property developer woes, China’s regulatory crackdown, raising the debt ceiling, difficulties in passing the US infrastructure bills, Fed tapering, and ongoing COVID concerns.  This may set up for a much rockier and more volatile quarter ahead for markets especially amid a growing wave of more hawkish G10 central banks.

Inflation Debate Rages On

Good morning, last week ended on a solid note for global equity markets, capped by strong gains in US stocks and in particular a surge towards the end of the session on Friday.  The S&P 500 is on track for its best month since November though in the next few days, month and quarter end rebalancing will continue to hold risks, which could result in increased volatility.  Another imponderable is potential follow through from huge equity sale block trades at the end of last week reportedly from Archegos Capital, which hit US media companies and Chinese tech stocks. All of this suggests risks of higher volatility in the days ahead.  

US interest rate markets came under renewed pressure, with yields backing up over the week, while the US dollar (USD) had a firmer week, with the USD index (DXY) ending above its 200-day moving average and technical indicators pointing to further gains this week.  CFTC IMM speculative positioning data (in the week to 23 March) shows that net aggregate USD short positions have been pared back further as USD sentiment continues to improve.  Positioning in most currencies vs. USD fell while Japanese yen (JPY) short positions increased further.  The oil market and container costs could be pressured higher by the continued delay in dislodging the stricken Ever from the Suez Canal, which seems to have made little progress over the weekend.

Attention this week will turn to a few key data and events.  Important among these will be President Biden’s speech in Pittsburgh (Wed) where he will likely give further details on his infrastructure plan and how it will be funded.  Key US data include the March ISM manufacturing survey (Thu) and March non-farm payrolls (Fri).  Solid outcomes for both are expected.  In Asia, focus will be on March purchasing managers indices (PMIs) across the region (Thu) including in China (Wed) where broadly positive readings are likely.  There will also be attention on the going malaise in Turkey’s markets since the sacking of the central bank (CBRT) governor while Europe continues to struggle with fresh virus waves, lockdowns, and vaccine reluctance as well as tensions over vaccine exports to the UK.

As President Biden gives his speech this week the debate about a potentially sharp rise in inflation rages on.  The Fed has tried to calm fears by highlighting that any rise in inflation over the coming months will likely be transitory.  However, with massive stimulus in the pipeline, economic recovery taking shape and the Fed set to keep policy very accommodative for years to come, market fears have risen as well as warnings from the likes of former Treasury Secretary Larry Summers.  Consumer inflation expectations remain largely subdued but the debate will not end quickly, and bond markets will be on tender hooks.  In the next few months inflation will turn up but this will largely be due to base effects as the collapse in activity in prices in Q1 last year falls out of the equation.  However, the jury is out on whether this will turn to more persistent inflation, something that could have a much more severe impact on markets and force central banks to belatedly tighten policy. 

Will India remain in the shadows?

Indian markets rejoiced in a big way following the outcome of the elections which put the secular Congress party back into power as the head of the United Progressive Alliance.   Stocks in India rose by a massive 17% and the rupee strengthened as markets gave a huge thumbs up to the outcome.   The margin of victory was bigger than had been expected and allows Congress to form a government with only minimal help from outside parties.  

Given that many had feared that the election would result in another unstable coalition supported by diverse parties each acting in their own interests,  the outcome was very positive.  In the event the result provides Congress with a strong mandate for change and reform.  The real question is whether they will grasp the opportunity or let it slip by and fall further behind into the shadow of China. 

There are of course many challenges that need to be faced on the home front including the alleviation of poverty for a huge chunk of the population, improving education, access to health care etc.   India also needs to move ahead with infrastructure spending, something which remains key to unlocking India’s potential growth and moving towards the pace of growth achieved by China.    As a comparison India spends around 6% of GDP on infrastructure spending compared to around 15% in China.   The results of such spending are obvious when looking at the pace of growth of both countries, with India growing relatively more slowly than China.

The issue is that even if the government has the mandate and the will to move forward with long awaited spending on infrastrucure, finding the money is the main problem.   The Indian government identified the need for $500 billion in infrastructure spending between 2007 and 2012 but the global financial crisis has seen a lot of potential investment disappear as banks bec0me increasingly strapped for cash and foreign investment shrinks due to lack of funding and an aversion to risk.   Restrictions on investments by funds that could potentially invest have also not helped whilst the government is limited in its spending by a huge fiscal deficit.    

The Congress party will need to grasp the opportunity that the election result has brought it and move forward to entice the investment needed to push forward with infrastructure plans.   One of the benefits of India’s slow pace of reform and gradual opening up of the economy is that the country has avoided the worst of the global economic crisis.  Even China will find it a huge challenge to shift its growth engine from export orientated growth to domestic consumption.  India is in a good position to take advantage of its relative resilience and now has a government with a strong mandate to do so.    It would be a great pity for India and the rest of the world, given the potential for the country to become a much stronger trading power, if the government did not take this opportunity by the horns once the celebrations are over.   If not, the rally in Indian markets may prove to have been a fleeting one.

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