Drivers for the Week of February 28, 2021

Here's a look at the main drivers in Developed Markets this week.
  • All eyes are on the US bond market this week; the dollar turnround Friday was noteworthy; the Fed’s nonchalance regarding rising yields is also noteworthy; markets are now pricing in odds of the first Fed hike coming in Q4 2022; the Fed releases its Beige Book report Wednesday; February jobs data Friday will be the data highlight for the week
  • UK Chancellor Sunak presents his budget Wednesday; eurozone reports February CPI; real sector data will be plentiful; ECB releases details of its bond-buying operations Monday
  • Japan has a quiet week; RBA meets Tuesday and is expected to keep rates steady at 0.10%; Australia also has a busy data week

Recent dollar gains are noteworthy. DXY traded at a new low for this move near 89.692 Thursday but then had its biggest one day gain Friday of 0.83% since last March. It is on track to test the February 17 high near 91.056 and then the February 5 high near 91.602. The euro is on track to test the February 17 low near $1.2025, while sterling is on track to test that same day’s low near $1.3830. USD/JPY has recovered from its brief time below 105 and traded Friday at the highest level since August near 106.70. It is on track to test that month’s high near 107.05.



All eyes are on the US bond market this week. The meltdown Thursday appears to have been exaggerated by some forced liquidation of bond positions. USTs came roaring back Friday, with 10-year yields closing the week at 1.40% vs. the 1.61% high Thursday and 30-year yields closing the week at 2.15% vs. the 2.39% high Thursday. However, equity markets sold off sharply and so investors are left with a bad case of whiplash. Bottom line: we believe parts of the reflation trade remain intact, including higher equities and lower bonds. However, the move in yields had become exaggerated and in need of a correction.

The dollar is the missing piece of the reflation trade as its turnround Friday was noteworthy. Indeed, the 0.83% daily gain in DXY was the largest since March 30. It’s unclear how much of the recovery is being driven by risk off impulses and how much by rising expectations of Fed tightening (see below). That may become clearer this week but whatever it is, we are still confident that the dollar is carving out a bottom in Q1. Price action this week will be key as we believe DXY is on track to test the February 17 high near 91.056 followed by the February 5 high near 91.602.

The Fed’s nonchalance regarding rising yields is also noteworthy. Virtually every other central bank is pushing back both verbally and concretely. What makes the Fed so confident that the US economy can weather this move higher in rates? For one, the vaccination program in the US, for all its problems, is still outstripping much of the world. This underpins a more optimistic growth outlook and certainly warrants a rise in longer-term US rates. But how much is enough? The Fed keeps saying that inflation is temporary but we sense some growing market skepticism. The upcoming March 16-17 FOMC meeting is taking on much greater significance now. It may be a final opportunity for the Fed to reset its messaging if the bond market continues to sell off.

Markets are now pricing in odds of the first Fed hike coming in Q4 2022. Previously, Q1 2023 was penciled in. If that timetable continues to accelerate, the Fed may have to push back more forcefully on any notions of tightening coming sooner rather than later. At the margin, enhanced Fed tightening expectations should help boost the dollar, as other central banks are likely to follow the Fed much, much later. We saw a similar dynamic play out during the financial crisis.
The Fed releases its Beige Book report Wednesday. Since the January 26-27 FOMC meeting, the economic outlook has improved significantly and Fed must acknowledge this. January retail sales were off the charts, while manufacturing surveys are showing continued strength in February. At the same time, the Beige Book will likely try to sound a note of caution as the labor market likely remains under stress in many Fed districts.

There will be plenty of Fed speakers too. Williams, Brainard, Bostic, Mester, and Kashkari speak Monday. Brainard and Daly speak Tuesday, followed by Harker, Bostic, and Evans Wednesday. Chair Powell speaks Thursday and may use this opportunity to push back more forcefully on bond market price action since his Congressional testimony last week. Bostic speaks Friday. At midnight Friday, the media embargo goes into effect and there will be no more Fed speakers until Chair Powell’s post-decision press conference March 17.

February jobs data Friday will be the data highlight for the week. Consensus sees 180k jobs added vs. 49k in January, with unemployment rising a tick to 6.4%. Both average hourly earnings and average weekly hours are expected to fall a tick to 5.3% y/y and 34.9 hours, respectively. Ahead of the jobs data, we get ADP private sector jobs Wednesday, expected at 180k vs. 174k in January.

The US growth outlook remains strong. The Atlanta Fed’s GDPNow model suggests Q1 growth is 8.8% SAAR, while the New York Fed’s Nowcast model suggests Q1 growth is 8.68% SAAR. Of note, Bloomberg consensus for Q1 is currently at 3.5% SAAR, picking up to 5.6% SAAR in Q2 and 6.2% in Q3. The same consensus sees core PCE picking up to 2.1% y/y in Q2 from 1.5% in Q1 before edging back down to 1.7% in Q3 and 1.8% in Q4.

Weekly jobless claims will continue to hold interest. Regular initial claims are expected at 755k vs. 730k the previous week, the lowest since late November. Regular continuing claims are expected at 4.3 mln vs. 4.419 mln the previous week, the lowest since March and were for the survey week containing the 12th of the month. Emergency continuing claims edged up by nearly 1 mln to 12.58 mln last week but are lagged and so this week’s numbers will be for the BLS survey week. All in all, the labor market is back on track to healing, albeit slowly.

Other important February snapshots will be reported. ISM manufacturing PMI comes out Monday and is expected at 58.6 vs. 58.7 in January. ISM services PMI then comes out Wednesday and is expected at 58.6 vs. 58.7 in January. The employment components for both will be watched closely for clues to NFP. In between, auto sales will be reported Tuesday and are expected at 16.20 mln annual rate vs. 16.63 mln in January.

Other minor US data will trickle out this week. January construction spending will be reported Monday and is expected to rise 0.7% m/m. February Challenger job cuts and January factory orders (1.8% m/m expected) will be reported Thursday. January trade (-$67.4 bln expected) and consumer credit ($12.0 bln expected) will be reported Friday.

Canada has a busy week. Q4 current account data and February Markit manufacturing PMI will be reported Monday. December and Q4 GDP data will be reported Tuesday, and are expected at -3.0% y/y and +7.2% annualized, respectively. January building permits will be reported Wednesday, followed by January trade and February Ivey PMI Friday. For now, fiscal policy will bear the load of stimulus as the Bank of Canada is likely to remain on hold for now. Next policy meeting is March 10 and rates are expected to remain steady at 0.25%.



UK Chancellor Sunak presents his budget Wednesday. Higher spending is a given as the jobs furlough program will undoubtedly be extended. The big question is how that spending will be financed. We do not think he will announce any tax hikes just yet, not when the pandemic is still ongoing. However, Sunak will likely signal that tax hikes will come in the not-so-distant future. He promised a “fair” way to tackle budget deficits, suggesting a mix of personal and corporate tax hikes when the time comes. Another budget is due in the fall and depending on how the reopening/recovery is going, Sunak may announce a more concrete timetable. This week, it’s can-kicking time.

Other than that, the UK has a quiet week. Final February manufacturing PMI will be reported Monday, followed by final services and composite PMIs Wednesday. After peaking around $1.4235 last Wednesday, sterling fell two straight days and retraced about half of the February rally. A break below the $1.3825 would signal a deeper correction and a test of the February 4 low near $1.3565. Sterling outperformance also faded, pushing EUR/GBP sharply. A break above the .8726 area would set up a test of the February 4 high near .8840/

The eurozone reports February CPI. Germany reports CPI Monday, where a steady EU Harmonized reading of 1.6% y/y is expected. The eurozone reading comes out Tuesday, which is expected to remain steady at 0.9% y/y. Of note, France and Spain reported their CPI readings last week. In EU Harmonized terms, the former fell a tick to 0.7% y/y vs. 0.5% expected and the latter fell half a percentage point to -0.1% y/y vs. 0.5% expected. The ECB has already signaled that it sees any acceleration in inflation as temporary and thus will have no policy implications.

Real sector data will be plentiful. Final eurozone February manufacturing PMI will be reported Monday, followed by final services and composite PMIs Wednesday. Germany reports January retail sales and February unemployment Tuesday. Sales are expected to rise 0.5% m/m vs. -9.1% in December, while unemployment is expected to fall -10k vs. -41k in January. Eurozone retail sales will be reported Thursday and are expected at -1.3% m/m vs. 2.0% in December. Of note, France reported weak January consumer spending last week of -4.6% m/m vs. -4.0% expected. Lastly, Germany reports January factory orders Friday and are expected to rise 1.0% m/m vs. -1.9% in December.

The ECB releases details of its bond-buying operations Monday. Last week, bank officials continued to jawbone rising yields. However, if actual ECB bond purchases picked up, then it would signal a much stronger commitment to maintain low yields. Mere jawboning will have little lasting impact and so if eurozone yields continue to rise, the ECB will have to step up its purchases and eventually increase the so-called envelope for PEPP again. At the December meeting, PEPP was increased by EUR500 bln and extended through at least March 2022. The March 11 meeting seems too soon for another increase but the ECB could set the table withs its updated macro projections. Guindos, Makhlouf, and Villeroy speak Monday while Knot and Centeno speak Thursday. Expect more jawboning is eurozone yields remain elevated.



Japan has a quiet week. Final February manufacturing PMI will be reported Monday, followed by final services and composite PMIs Wednesday. January jobs data will also be reported Tuesday, with the jobless rate expected to rise a tick to 3.0% and the jobs-to-applicant ratio to remain steady at 1.06. Q4 capital spending and company profits data will also be reported Tuesday. Although the economy is likely to contract in Q1, the Bank of Japan is likely on hold for now. That said, all eyes are on its policy review. Results are expected at the next meeting March 18-19. Simply put, the bank is in a bind and cannot tinker with its YCC program with long rates rising. Neither can it cut rates more negative and so we are left expecting superficial changes to its policies.

Reserve Bank of Australia meets Tuesday and is expected to keep rates steady at 0.10%. It just delivered a dovish surprise at the February 2 meeting when it extended its asset purchases beyond mid-April to September with an AUD100 bln increase. After aggressive asset purchases last week by the RBA, the 3-year yield closed below target at 0.097%. However, the long end of the curve continued to sell off, with the 10-year yield approaching 2% and the 30-year approaching 3% to end the week. Those yields have opened this week sharply lower in a catchup move to the Friday drop in US rates.

Nevertheless, the RBA needs to push back harder at the continued rise in interest rates. It will likely pledge stronger action to maintain YCC and may promise to increase QE as needed in the coming months. One extreme possibility is that the RBA does what the BOJ did and simply drop any numerical limits on QE. Under pure YCC, purchases should be flexible and open-ended, not numerically limited. This is a much stronger statement from the bank, though it will not really involve any change to the YCC program.

Australia also has a busy data week. Final February manufacturing PMI will be reported Monday, followed by final services and composite PMIs Wednesday. Q4 current account data will be reported Tuesday, followed by Q4 GDP data Wednesday. January trade and final retail sales will be reported Thursday. The economy has been performing well but signs of softness in the mainland China economy are cause for concern. Indeed, preliminary trade data showed a sharp drop in exports and this bears watching. After peaking above .80 last week, AUD has reversed sharply and is on track to test the February low near .7565 and the RBA will be quite happy with recent currency weakness.

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