To finance or not to finance

Economic data is starting to register the upward trajectory in global growth expectations, while the demand for treasury securities seems to be waning—raising questions about continued public spending into next year. At least the recovery is here, and consumer spending is set to reinvigorate much diminished retail and travel sectors at long last. Riding on this wave of optimism means asset prices are now factoring in brighter prospects in the second half of 2021, ostensibly leaving safe and low-yielding treasury securities to bake in the metaphorical sunshine.

Of course, central bankers have been warning us that unemployment rates remain high and support measures are still required to help prevent wide-spread social harm. Federal Reserve Chairman Jerome Powell called it ‘a turning point’, where fiscal spending plans are expected to lift inflation higher and rapidly accelerate employment. Inflation hawks and fiscal conservatives are understandably unnerved by the prospect of government budgets ‘hitting the gas into a red light’.  While we’ve discussed the inflation element of those concerns over the past several weeks—concluding that they are overdone—the fiscal conservatives have a very valid point.

Since 2008, public debt as a percentage of GDP has nearly doubled in both the US (68% to 129%) and UK (46% to 98%), which raises the larger question of financial stability. In the US, this figure exceeds even post-war reconstruction under President Truman in 1946, while the UK hasn’t been in this much debt since the Big Freeze in 1963. Obviously, the global financial crisis and coronavirus have impacted most countries, so on a relative basis perhaps the issue seems less acute. 

Much like the perennial debt ceiling negotiations in the US, this brings the question of sustainable debt levels under greater scrutiny. The high levels of national debt to GDP prompts the question about additional spending and what quantum of national benefit justifies an increase of GDP above 100%, 150% or even 200%, etc. Western economies have been more ready to issue debt to fund rescue programmes than emerging markets, which has seemingly made them more susceptible to a credit market backlash.

Bottom line: There is always a concern that pushing debt levels higher will push countries across some undefinable event horizon, where cost of financing (interest rates) will start to register some skepticism over national solvency. The rise of Modern Monetary Theory in recent years has attempted to draw a distinction between external and internal debt, also termed national sovereignty. The idea is that the United States issues debt in USD which the central bank controls via monetary policy. An emerging market country, however, might issue USD-denominated debt because it is less costly at the outset, but in the event of depreciation of its currency could be saddled with unrepayable interest expenses. Perhaps relatively larger debts in western nations are not as straight forward as their market impact.

 

The week ahead

GBP

The Pound fell over 2% on a trade-weighted basis last week, marking its worst performing week since December 2020. Sterling’s decline was aggravated by reports of several nations suspending the rollout of the UK’s AstraZenica vaccine because of side-effect risks. The UK are now reporting under-30’s will receive a different vaccine. In addition, last week’s rapid decline, particularly against the Euro, may be explained by profit-taking after the pair climbed 7% in the first quarter of 2021. On a brighter note, the UK has entered the next phase of easing lockdown restrictions which could help support the currency in the coming weeks on releases of improved economic data. The data calendar is quiet this week but several MPC members will be speaking throughout.

  • Tuesday’s Industrial and Manufacturing production are both expected to show 0.5% growth in February after both sectors contracted in January.
  • Also on Tuesday, GDP in February is expected to show 0.5% growth after contracting 2.9% in January.
     

​​​EUR

The Euro had its best performing week of 2021 last week on a trade-weighted basis but remains nearly 2.5% off its January high. The Euro had performed poorly against its peers in recent weeks due to nations continuing to impose restrictions and a slow vaccination rollout. Although the coronavirus situation in Europe remains bleak, vaccinations across the Euro area are improving, although the economic benefit may not be present in data releases for several weeks. On Wednesday, ECB President Lagarde will be speaking.

  • Monday’s Eurozone retail sales for February beat expectations coming in at 3.0%, compared to January’s contraction of -5.9%
  • Tuesday’s German ZEW sentiment expectations survey is expected to improve from 76.6 to 79.0, along with the current situations survey which is expected to read -54.6, up from -61.0 previously.
  • On Wednesday, Eurozone industrial production for February is expected to read -1.2%, down from 0.8% in January.
  • Friday’s Eurozone month-on-month CPI reading is expected to show 0.9% growth in prices, while the year-on-year CPI reading is forecast 1.3%, up from 0.9% previously.

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USD

Following the US Dollar’s strong performance in Q1, the Greenback fell 1% last week while Treasury yields slid. Fed Chair Jerome Powell claimed the US economy is at an ‘inflection point’ where he expects rapid economic growth and job creation in the coming months. Despite these comments, Fed officials remain dovish with their monetary policy stance. Powell further claimed it was ‘highly unlikely we would raise rates anything like this year’. Powell will be speaking on Wednesday afternoon followed by several other FOMC members.

  • Tuesday’s CPI reading for March is expected to read 0.5%, up from 0.4% in February while the year-on-year reading is expected to climb from 1.7% in February to 2.5% in March.
  • Thursday’s initial jobless claims are expected to tick lower to 700k from 744k the previous week.
  • Thursday’s Retail Sales for March are expected to show 5.5% growth after contracting 3.0% in February.
  • Thursday’s Empire Manufacturing reading is expected to improve to 18.8 for April compared to 17.4 in March.
  • Thursday’s Industrial Production figure for March is expected to show 2.5% growth after contracting 2.2% in February.
  • On Friday, the University of Michigan sentiment survey for April is expected to tick higher to 89.0 from 84.9 which would mark the survey’s highest level since March 2020.

 

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