Markets Feb 28

Markets this week: Bond yields, PMIs and inflation outlook

All eyes will be on Fed officials; disappointing China factory data may also weigh 

Markets this week: Bond yields, PMIs and inflation outlook

Economic events

Financial markets will remain subdued at the start of the week, watching US Treasury moves and following downbeat factory data from the world’s second largest economy. This week’s speeches by US Federal Reserve officials gains more prominence after markets price in a pivot away from easy monetary policy. The benchmark 10-year Treasury yield shot up to a one-year high of 1.614% last week and is nearing the dividend yield return of the S&P500 index.

Jeff Rosenkranz, fixed income portfolio manager at $3.5billion Shelton Capital Management told Asia Times Financial many investors were caught off-sides and were not set-up well for this move in rates and they are re-evaluating their portfolios and starting to make adjustments – the time taken by larger funds is longer.

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“Even though the Fed is telling us that inflation is not a problem - the market doesn't necessarily believe this. Inflation expectations are rising on stimulus and a potential infrastructure bill thereafter. And now real rates are rising as well given the momentum building for strong growth in the economy as the vaccine rollout progresses and picks up steam,” he said.

“Lastly, once rates started moving for fundamental reasons, certain technical factors kicked-in and exacerbated the problem - including MBS investors adjusting hedges."

Analysts say the positive correlation between share prices and US bond yields – that has been in place since 1997 – is likely to turn negative.

“The basis is that the key macro risk to equities is shifting from low inflation/deflation to higher inflation,” said Arthur Budaghyan, BCA Research Chief Emerging Markets Strategist.

“Global growth stocks will underperform value stocks. US equities will lag international markets.”

Factory activity

Sentiment will also turn watchful after China’s factory activity struck the lowest level since last May . China is the only major economy to have registered growth last year, despite posting a first-quarter drop in GDP, the first contraction in decades. But the official manufacturing Purchasing Manager’s Index (PMI) fell to 50.6 from 51.3 in January, data from the National Bureau of Statistics (NBS) showed on Sunday, falling harder than expected.

On the positive side, investors will cheer the US House of Representatives passing the $1.9 trillion coronavirus relief package, with Secretary of the Treasury Janet Yellen saying the plan ensures “people make it to the other side of this pandemic and are met there by a strong, growing economy”. Sentiment will also be boosted by the U.S. Food and Drug Administration authorization of the J&J vaccine for adults. It is expected to speed up the vaccine rollout as it requires only one jab.

In Asia, Hong Kong’s Hang Seng index will announce a potential major revamp for the gauge. It is expected more new economy stocks are to join under the changes, making the benchmark more volatile. Hong Kong’s stock market has seen an increasing number of mainland tech listings as these giants have avoided the traditional route of listing on US markets.

 During the week, markets will await the release of worldwide PMI surveys that will shed light on economic growth and inflation trends.

Flash February data hinted at the strongest developed market expansion for three years, led by the US, which has contributed to further upward revisions to many forecasters’ expectations for worldwide GDP in 2021, said Chris Williamson Chief Business Economist, IHS Markit.

“Insight from the PMIs will therefore be sought into the extent to which these inflationary pressures are developing, and if they might be spilling over to the service sector, which would augur for a potentially bigger impact on the longer term inflationary picture,” he said referring to the recent pricing pressures on account of supply chain disruptions.

Top Chinese government officials will meet at the Chinese People’s Political Consultative Conference and the National People’s Congress sessions to be held on 4th and 5th March. Past meetings have focused on economic targets and policy changes required to achieve these targets. However, this year the focus will shift from GDP targets to emphasis on high quality growth as the pandemic continues to ravage economies across the world.

"We expect a clear roadmap for self-sufficiency of advanced technology and achieving carbon neutrality. And we expect some investment numbers and timelines from the Two Sessions," said Iris Pang, ING Bank's Chief Economist, Greater China.

Later in the week, markets will parse US jobs data with economists surveyed by Bloomberg anticipating an increase in the unemployment rate to 6.4%, with a tally of about 180,000 new jobs.

Fund flow

China bond and equity funds set new inflow records in the week ending Feb. 24 while Hong Kong Equity Funds posted  a 24-week high.

“With full-year GDP forecasts for China running around 8%, the country is central – along with the stimulus-driven US economy – to the global reflation story that has gripped markets since the fourth quarter of 2020,” said Cameron Brandt, EPFR’s Director, Research while adding that according to the latest country allocations data for the diversified Global Emerging Markets (GEM) Equity Funds one out of every three dollars they took in was going to buy Chinese equity.

“This appetite for China’s growth story has curbed investor interest in supply chain relocation stories,” he said while highlighting that Vietnam Equity Funds posted their biggest outflow since mid-4Q18, Philippines Equity Funds experienced net redemptions for the fourth time in the past five weeks and Mexico Equity Funds chalked up their second largest outflow year-to-date.

Inflation was the other theme that drove investment flows during that week - Bank Loan and Convertible Bond Funds extended their longest inflow streaks since 3Q18 and 1H14 and Inflation Protected Bond Funds absorbed over $1 billion for the sixth time in the past eight weeks.

The US stimulus story continued to drive investors as US Equity Funds chalked up their fourth inflow over $20 billion since the beginning of 4Q20. But the sharp rise in US Treasury yields saw major withdrawals in the days after the reporting date – this could be reflected in next week’s data.

“Rising government bond yields over the past week have pushed investors to reduce duration exposure. Long-term IG funds have recorded outflows,” said BofA Securities strategists in their note.

“Global EM debt funds enjoyed an inflow large enough to offset last week's first outflow since Sep '20. The asset class remains by far the best performer in the flow universe YTD.”

Emerging Markets Bond Funds would have registered outflows in aggregate but for the record-setting flows into dedicated China Bond Funds. China Bond Funds set a new weekly inflow record.

Economic data calendar

Major rating changes last week