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Another Big Week Ahead

Now that the first estimates of Q1 growth in the US, China, and the EMU, which account for around 70% of the world’s economy, have been reported, March’s economic data will lose some of its gravitas. Indeed, the April PMIs and some other survey data,…

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Now that the first estimates of Q1 growth in the US, China, and the EMU, which account for around 70% of the world's economy, have been reported, March's economic data will lose some of its gravitas. Indeed, the April PMIs and some other survey data, including business and investor confidence, and a series of regional Fed's manufacturing surveys have already given a taste for how the second quarter is beginning.   And it is strong.  

Outside of the final PMI readings, which for large countries, the preliminary report is sufficiently accurate that the final report is hardly new news, the most market-sensitive high-frequency data point, US April employment, is released at the end of the week.   Another monster job report is expected after a 916k increase in nonfarm payrolls in March.  The early respondents to the Bloomberg survey have a median guesstimate of nearly 980k jobs, though there are already some projections of a million or more. Private sector employment is anticipated to be around 15% higher than March's increase of 780k.  

The unemployment rate will most likely fall below 6%.  This is significant because the 10 and 20-year averages are 6.0%-6.1%.  This is not an attempt to resurrect the Phillips Curve; after all, with unemployment bouncing around 3.5% pre-Covid, wage pressures were mild, and inflation was undershooting its target.  The takeaway is that, as Fed Chair Powell has suggested, the economy is at an inflection point, and activity is accelerating.  And indeed, progress toward maximum employment is being achieved, even if there is more work to be done.  

On April 2, when the US reported the well-above expectations March nonfarm payroll, the 10-year Treasury yield settled at 1.72%.  It has not seen that level since and, instead, dropped almost 20 bp before finding traction again.  Arguably, not totally unrelated, the dollar depreciated against all the major currencies in April.  The greenback fell against most emerging market currencies in April, as well, and the JP Morgan Emerging Market Currency Index snapped a three-month slide.  

If the US employment report is the most market-sensitive economic, then the UK's local elections are the political event of the week.  In part, the election is a referendum on the government, its handling of the pandemic, and Brexit. Although the UK was hit particularly hard last year, the vaccine rollout appears to be exemplary and barring a fresh setback, it will be among the first large countries to lift all restrictions (June 21).  

The success of the vaccination drive appears to be offsetting the other knocks against the UK government.  Even though the party in power tends to lose seats in the local election, and the Conservatives have to defend more seats than Labour, the polls suggest the Tories will do well.  There are 5000 council seats and 14 mayors contests, including London.  It may not be an auspicious beginning for Starmer, the new Labour leader.  

The costs/benefits of Brexit are still evolving.  One political cost of implementing it is that the head of the Democratic Unionist Party in Northern Ireland, Foster, bowed to the mounting pressure and will step down as the First Minister at the end of June. The DUP supported Brexit, but the border checks between Northern Ireland and Britain were too much.  Many feel betrayed by UK Prime Minister Johnson, who previously scoffed at the suggestion of a border in the Irish Sea, and the Northern Ireland Protocol.  Northern Ireland's government does not face voters until next year. 

Another cost of Brexit may be evident in the local elections in Scotland.   Internal strife led to a split in the Scottish Nationalist Party, but it appears that a pro-independent majority will be secured.  The SNP is advocating a referendum in the new parliament that will be elected next week.  It would shoot for the middle of the five-year term, so roughly mid-2023.  The Johnson government argues that the 2014 referendum was a once-in-a-generation event. The SNP counters that Brexit, which the Scottish people opposed, was a material change.   

A critical issue that needs to be explored for Scotland is whether the EU would welcome it and expedite membership.  Without it, an independent Scotland may not be economically viable.  The EU does not want to encourage separatist movements, for which there are several in Europe.  On the other hand,  its animosity toward the UK for pursuing Brexit in the first place, but also how it has handled itself, like unilaterally deciding to stop (temporarily) checks on goods going into Northern Ireland from the rest of Britain, may tempt it to find a reason why the Scottish situation is unique.   

The government in Wales (Senedd) has been dominated by Labour since its inception in 1999.  The outcome is clouded by two developments. The first is with Brexit achieved, the UKIP party is a shadow of its previous self.  As one might expect, former  UKIP voters are drifting (back) into the Tories' fold.  The other unknown is the impact of allowing 16-17-year-olds to vote for the first time.  The younger cohort can vote in Scotland.  

Despite parallels often drawn between the UK and US political culture, this is a stark contrast.  The franchise is being extended in Wales (and has already been extended in Scotland), while in the US, many states are considering legislation that will likely result in fewer people voting.  Some argue that 16-17-year-olds will not vote in high numbers and are not sufficiently informed.  That may be the case, but that argument has been used to restrict the franchise to other groups historically, and many important decisions on both sides of the Atlantic appear to have been made with small majorities.  Some have suggested that if that younger cohort got to vote throughout the UK, it might still be in the EU.  I anticipated expanding the franchise to that younger cohort in my 2017 book, Political Economy of Tomorrow, and still suspect that more representative governments will move in this direction over time.  

As fascinating as these developments may be, the Bank of England meeting may have a bigger market impact.  The success with the vaccine rollout and the measured re-opening of the economy will boost official confidence that growth will strengthen.  The recent string of data has been strong, and the central bank will likely pare back the magnitude of the contraction in Q1 and boost the current quarter's prospects.  It is possible that with the economy opening sooner than may have been anticipated, that the growth is pulled forward a bit.  

The BOE may safely anticipate that the economy will return to pre-covid levels.  Officials may still talk about a high bar to a rate hike, and its inflation projections will remain below target.  However, this says nothing about tapering, and that seems like a distinct possibility even if not at the May 6 meeting.  While the Fed's Powell says it is premature to even talk about tapering, the BOE is likely the next central bank to indicate that the economic recovery will allow it to move past peak monetary support.  It is possible to see it sooner, depending on several considerations, but late Q3 seems like a reasonable timeframe to consider.  

Among the high-income countries, two other central banks meet in the coming days.  The Reserve Bank of Australia on May 4 in Sydney.  It is in no hurry to reduce its monetary stimulus.  The economy continues to recover.  Despite the economy strengthening and the full-time job loss practically fully recouped, price pressures are modest, and the underlying rate (trimmed mean) rose 1.1% year-over-year in Q1, a record-low.  Its current QE tranche will likely be complete in a few months, and a decision about another need not be made at this meeting.  

On the other hand, its yield-curve control is on the April 2024 bond.  It needs to roll that out to the November 2024 issue, which also buys it a few more months to decide about tapering.  It is not seen as stopping "cold turkey," so that would imp y at least another round of bond-bond-buying, albeit smaller.  The RBA will update its quarterly forecasts at the end of next week, and the direction seems clearly to the upside.  Also, a few days later (May 11), the government will present its budget, and the early indication is that it will support the economy.  The more rapid recovery than anticipated means that deficit and debt ratio projections may also be lower.  

Norges Bank, Norway's central bank, meets on May 6.  At its March meeting, it left no doubt that it was in front of the line of high-income countries removing monetary stimulus.  Specifically, it indicated that it could start raising rates earlier than it previously anticipated.  It was explicit.  The policy rare would likely be hiked in the second half of this year.  Many have penciled in September.  Neither the economic data nor the vaccine rollout is likely to spur a reversal of Norges Bank's forward guidance.  

A few other central banks meet that will be of interest.  Poland's central bank meets on May 5. It does not seem prepared to move now and possibly for the remainder of the year.  The Czech central bank meets the next day.  It is likely to be among the first central banks to hike rates in Europe, starting perhaps in the summer.  The central bank itself projected three hikes this year, but given the slower rollout of the vaccine and the EU's fiscal stimulus, the central bank may scale back the number of hikes.  

Brazil's central bank meets on May 5.  It had already signaled that it would likely follow the 75 bp rate hike in March with another one of the same magnitude. The Brazilian real was the strongest emerging market currency in April, appreciating about 5% against the dollar, but it is still off 3% for the year, after depreciating by 22.5% last year.  Brazil's IBGE measure of inflation rose to 6.17% in April, year-over-year from 5.52% in March.  It was the tenth consecutive increase in the year-over-year rate, which finished last year at 4.23% and 2019 at 3.91%.  The Selic rate stands at 2.75%.  Additional rate hikes will likely be delivered this year.  

A few days before Turkey's central bank meets on May 6, April, CPI figures will be released.  The market anticipates another increase, with the headline rate rising above 17%, from almost 16.2% in March.  It would be the highest since the first half of 2019.  One can only imagine the pressure the new central bank governor is under to unwind the 200 bp hike of his predecessor, which cost him his job.  Foreign investors have sold roughly the same amount of Turkish bonds in the five weeks since Agbal was dismissed as the bought in the previous ten weeks.   The lira itself has depreciated by a little more than 12% in the last five weeks. A rate cut is unlikely, but if delivered or some maneuver is adopted that eases the funding pressure, the lira will likely be sold again.  The key level for the dollar is around TRY8.50.  




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