Wall Street and global stock markets added to already impressive gains in December, fueled by the roll out of vaccines that are widely seen as driving a robust recovery in 2021 after the volatile path seen in 2020. Adding to the optimism was the passage of a fresh stimulus bill in the U.S. and a Christmas Eve Brexit agreement. The accumulation of upbeat developments continued to overshadow the challenges facing the economy in the very near term, as surging infections triggered increasingly stringent lockdowns in the U.S., Europe and parts of Asia, suggesting a rocky start to the year for global growth. Meanwhile, bond markets continued to take a more measured view of the growth outlook, as the uptick in yields since March has sharply undershot the magnitude of the upward trajectory in equities. The tension between dismal near term and sunny medium term outlooks will continue to drive volatility in equity, bond and currency trading as the New Year begins.
Key Market Drivers
- Equities add to impressive gains, driven by roll out of vaccines
- Vaccines launched in the U.S., UK and Europe provide light at end of tunnel
- EU and U.K. agreed on trade deal, should smooth UK’s exit from EU’s market
- President Trump signed $2.3 tln omnibus spending bill; has $900 bln in Covid relief
- FOMC made no big changes but emphasized uber-accommodative posture
- ECB strengthened PEPP and TLTRO programs, as expected; rates were unchanged
- BoJ left policy unchanged, extended emergency funding program to September
- U.S. data largely confirmed production continued to rise sharply in Q4 despite virus
- Eurozone economy seen contracting in Q4 under weight of increased virus restrictions
- Japan’s GDP growth pace on track to moderate in Q4 after the strong Q3 rebound
- China’s recovery continues to broaden
- Wall Street posted new record highs; global stocks made solid headway too
- Longer dated Treasury yields edged higher in December but remain historically low
- WTI crude oil firmed as vaccine roll out bolstered demand restoration hopes
- BoE, SNB and Norges Bank Maintain Policy Accommodation
Vaccines rolled out in the U.K, US and Europe during December, providing the market with a light at the end of the tunnel as infections, hospitalizations and restrictions soared. Front line health care workers and the elderly have priority, but expectations have grown that wider availability will be the case by the middle of next year, if not a bit earlier. Japan will begin to vaccinate in late February, according to a Bloomberg report that cited local media sources.
The EU and U.K. agreed to a Christmas trade deal, which should help to smooth the U.K.’s exit from the EU’s single market. The compromise secured tariff-free trade on most goods, and helped ensure continued cooperation on crime-fighting, energy and data sharing. However, it did not come close to replicating the U.K.’s existing relationship with the EU. Non-tariff trade barriers will increase as the U.K. leaves the customs union and the single market — hence, there are likely be some challenges, especially at the beginning. However, companies on both sides of the channel can now start to plan for the future — which should bolster confidence, especially given that a hostile split has been avoided.
President Trump signed the $2.3 tln omnibus spending bill as the month of December came to a close, averting a partial government shutdown and funding the government through September. More importantly for the market, the bill includes the $900 bln pandemic relief measures that will add PPP funds, boost extended unemployment benefits and the eviction moratorium, support the airlines, and increase money for vaccine distribution. The bill provides $600 checks to individuals. Congress indicated it would review Section 230 which advantages big tech, and will look into voter fraud issues.
FOMC Tweaks Its Message
The FOMC didn’t make any big changes in its policy stance at the December 16 meeting. However, it did tweak its statement to emphasize its uber-accommodative posture, which was underscored several times by Chair Powell in his press conference. As expected, the Fed left its rate stance unchanged with the 0% to 0.25% funds rate band left intact. And the forecasts indicated it would remain in place through 2023. The statement repeated that the economy and labor market have continued to recover, but they are still well below pre-pandemic levels. Inflation continues to run “persistently” below the 2% long-run goal. The markets were looking for more detail on forward guidance, and saw some chance for an extension of QE purchases, but they were not forthcoming. There were no indications that any shifts in guidance or asset purchases would be made near term as Powell indicated the economy is suffering from the pandemic, not a lack of accommodative conditions. The door was left open if action became necessary.
There were few changes in the policy statement relative to the November statement. The most significant change was in the forward guidance. “The Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” In November, the Fed stated: “the Federal Reserve will increase its holdings of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning and help foster accommodative financial conditions.” Though only a qualitative change, attaining “substantial further progress” will take a long time, suggesting accommodation will be in place well into the future.
The Fed remains cautiously optimistic on the recovery, but Powell continued to stress that it will be a long road with considerable risks. According to the statement “Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year. Weaker demand and earlier declines in oil prices have been holding down consumer price inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.” It was again indicated that the “path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
The ECB did what most had expected at the December 10 meeting — strengthen PEPP and TLTRO programs, while leaving official rates unchanged. It wasn’t the policy bonanza some in the market had hoped for, although ECB Executive Board member Schnabel signaled in the run up to the meeting that this was unlikely to happen, so it was ultimately not much of a surprise. The central bank’s focus is on maintaining very favourable financing conditions for both governments and companies, against the background of a pandemic that not only has weighed heavily on the growth outlook, but also contributed a further fragmentation of economies and markets. Official interest rates were left unchanged, which at current levels is hardly a surprise. The deposit rate was already firmly in negative territory, as are market rates in many segments. With the advent of vaccination programs there clearly is no appetite to cut rates again. Not that the ECB rules out such a step — if the situation deteriorates again, or an overshooting currency undermines the inflation outlook, the ECB won’t shy away from using that instrument if necessary.
As expected, the BoJ left policy unchanged at the December 18 meeting while extending the emergency funding program to September as expected. Warning of downside risks, the BoJ vowed to firmly support the funding of companies through a still difficult period. The BoJ is not planning to review negative rates, the Bank’s Governor said, but will look at yield curve control and asset purchases and extending Covid programs again if needed.
The BoE left rates on hold at the December 17 meeting but signaled a willingness to act if there was not a Brexit deal (which there was at month end). Notably, the Bank of England’s Vlieghe caused a stir on December 18 after he once again backed negative rates. However, the launch of the vaccines and the Brexit deal suggest that there is little possibility that the BoE will need to resort to negative rates.
Economic Trends
A challenging near term for the global economy (ex-China) contrasts with an increasingly optimistic outlook for the medium term as the rollout of vaccines allows a return to normal activities by the middle of 2021.
In the U.S., a heavy docket of economic reports just before Christmas largely confirmed that production continued to rise sharply through Q4 despite a mounting coronavirus headwind for retail activity into late-November and December, leaving hefty gains for inventories. The personal income report revealed a big Q4 pull-back in income subsidies, and weak spending prompted a mark-down in the Q4 real consumption growth forecast to 2.8% (q/q, saar) from 4.0%. The durable goods report supported a solid Q4 growth forecast of 14% for real fixed investment, while ongoing wide gyrations in the weekly claims data alongside a steady downtrend for continuing claims suggested that the labor market continued to expand despite new virus restrictions. Based on the most recent batch of data, our GDP forecasts now sit at 4.3% for Q4 and 3.5% for Q1. Growth is expected to pick-up in Q2 as vaccinations allow a gradual return to normal activities — a 5.5% GDP rate is projected for Q2, a 5.4% clip for Q3, and a 4.6% pace for Q4. All told, GDP is expected to rebound 4.9% in 2021 after a -3.5% drop in 2020.
Europe’s economy is on track to contract in Q4 under the weight of increased virus restrictions, but the roll-out of vaccines should return the economy to growth in Q1. Also, the Brexit deal has removed considerable uncertainty facing business, which should provide additional support to growth in 2021. Consequently, GDP is seen falling -2.2% in Q4 (q/q, sa) after the 12.5% rebound in Q3 and a -11.7% plunge in Q2. Eurozone growth should improve 1.0% in Q1, accelerating to a 1.6% clip in Q2 and slowing slightly to 1.4% in Q3 and 1.0% in Q4. For the year, Eurozone GDP is on course to rebound 4.0% in 2021 after a -7.4% contraction in 2020.
Japan’s economy is expected to moderate to a 3.5% clip in Q4 (q/q, saar) following the 22.9% rebound in Q3 from the -29.2% plunge in Q2. The bounce in Q3 was a bit firmer than anticipated, but the strength of the Q3 GDP report was undercut by a heavy contribution from government spending. Consumer demand picked up and exports also climbed, as trade flows resumed after the weakness in Q2. As was the case in the U.S. and Europe, the level of GDP in Q3 was below the pre-pandemic level. Government spending remains a crucial driver of the economy. The government and BoJ were struggling to transition the economy to self-sustaining growth even before the pandemic ravaged the global economy. Japan’s economy was subject to the same headwinds as the U.S. and Europe, namely surging virus infections in Q4. However, the eventual roll out of the vaccine and continued very accommodative fiscal and monetary policy drive expectations for growth in 2021 — we expect quarterly GDP gains through 2021 of 1% to 3%.
China’s recovery broadened further, as manufacturing sentiment measures were firm and a key non-manufacturing sentiment measure remained elevated. GDP is expected to accelerate to a 6.0% y/y pace in Q4 following the 4.9% growth clip in Q3 and 3.2% gain in Q2. China’s economy contracted -6.8% y/y in Q1 of 2020 due to the pandemic and lockdowns.
Market Developments
Stocks moved higher in December after posting double digit gains in November (with the exception of China), with the bulk of the risk-on rally driven by enthusiasm over the rollout of vaccines. The passage of the stimulus bill in the U.S., the Brexit compromise, and the reiteration from central banks to maintain accommodation for an extended period of time (and do more if needed) also underpinned equities.
Wall Street kept the party going, adding to already massive gains through December — the Dow, S&P 500 and NASDAQ closed out the year at record high levels. The Dow was 2% higher by late December relative to early December, the S&P was 2% firmer and the NASDAQ improved 4%. All three indexes closed at record highs as December came to an end. Compared to March lows, the Dow was 64% higher, the S&P 500 up 67% and the NASDAQ a remarkable 88% firmer. Moreover, the rally saw a further broadening of gains as shares of firms that would benefit from a return to normal saw continued buying interest. European bourses also climbed in December versus the beginning of the month, with the Euro Stoxx 50 up 2% while Germany’s DAX was 3% in the green to a record level. The UK’s FTSE rose 3%. Japan’s Nikkei 225 improved 3% to a fresh all-time high. China’s CSI 300 rose 1% to a new record high.
Longer dated Treasury yields edged higher in December, contrasting with the robust rally on Wall Street. The 10-year Treasury yield ticked up to 0.930% from 0.839% at the end of November. The rate was in the 1.60% region during early February. A more uncertain outlook in Europe and the UK saw rates largely move sideways — the German 10-year Bund improved to -0.583% from -0.640% at mid-month but was below the -0.522% at the beginning of December. The UK’s Gilt fell to 0.204% from 0.350%, but was above the 0.169% reading from mid-month. The 10-year Japanese Government bond (JGB) was little changed at 0.013% from 0.017%, but did climb from a -0.003% nadir at mid-month. Overall, the fixed income market continues to take a more measured view of the vaccine — indeed, it will take some time to manufacture, distribute and vaccinate the large numbers of people needed for a return to normal. In the meantime, the U.S. and Europe face a challenging winter as cases spike and lockdown measures return. Meanwhile, central banks continue to supply the system with considerable liquidity, keeping a lid on rates by design.
WTI crude oil rallied to the $49 level by late in December from $44.50 at the start of the month as optimism that the vaccine will restore demand next year continued to lift prices. Also, the U.S. Covid stimulus bill supported price expectations. Of course, further Covid outbreaks could keep demand suppressed until vaccine distribution becomes more widespread, which would cap oil prices. Indeed, looking ahead, further price gains are likely to be limited, as Covid continues to impact demand, and as extra crude output from OPEC and non-OPEC producers is expected to increase through 2021.
The continued firming in risk-on sentiment that benefited stocks and crude oil resonated through commodities in general for another month, further lifting the Reuters/CRB commodity index 4% to 165 by the beginning of December. Recovery hopes had the edge over worries about demand destruction.
BoE, SNB and Norges Bank Maintain Policy Accommodation
The BoE, SNB and Norges Bank all maintained their accommodative policy settings at their scheduled meetings in December. The near term outlook still remains challenging but the prospect of vaccination programs leaves both upside and downside risks for next year, with the outlook unusually uncertain. For now that has central bankers sitting on the fence, hoping for fiscal policy to support the recovery.
The BoE had topped up its asset purchase program by a further GBP 150 bln at the last meeting and it would have needed a confirmed breakdown of Brexit talks for central bankers to move into crisis mode, especially against the background of vaccination programs that have already started in the U.K. The stop and start of lockdowns have led to mixed signals from data, with October production numbers still stronger than anticipated, but confidence deteriorating in November when strict lockdowns were back in place.
Employment data was also was mixed, with the ILO unemployment rate rising less than feared in the three months to October, but the BoE highlighted that “other indicators suggest that labour market slack has increased by more than implied by this measure.” Furthermore, the extension of the government’s furlough scheme has helped to keep job losses down for now, but these schemes cannot be extended forever and it remains to be seen what will happen once they run out.
Inflation fell back more than anticipated in November — to just 0.3% y/y from 0.7%, but the BoE expects a sharp rebound “towards target in the spring, as the VAT cut comes to an end and the large fall in energy prices earlier this year drops out of the annual comparison.” Still, vaccination programs may have started but the strict lockdown in November and December means that Q4 growth is likely to be weaker than anticipated in the BoE’s November report.
The outlook for the economy remains unusually uncertain and depends not just on the evolution of the pandemic but also on Brexit developments and the responses of households, businesses and financial markets to the developments. The main policy statement did not delve into the trade talks, but the minutes reported evidence from the Bank’s Agents that suggested only around 70% of businesses trading with the EU were fully prepared.
Some firms also reported that their preparations were hindered by challenges related to Covid. Businesses also had “concerns about factors beyond their control, such as the resilience of supply chains and disruptions at ports”. Despite the preparations, most companies expect significant short-term disruptions, also exacerbated by the recent congestions at ports. Indeed, even with a deal, non-tariff trade barriers will go up and it will likely be a difficult and confusing start to the new arrangements, which are still not known in full.
With all this in mind the BoE kept overall settings unchanged at its meeting on December 17, but extended the Term Funding Scheme by six months, while focusing on flexibility in the asset purchase program. Should market functioning worsen materially again, the Bank of England could increase purchases, but at the same time, there is flexibility to slow the pace of purchases later if the economy recovers as planned next year. Fiscal policy is already expected to support the economy next year. And with the budget deficit rising sharply, BoE support will be needed to keep financing conditions favorable.
What holds for the BoE pretty much holds for other central banks as well, although in Switzerland rates are already firmly in negative territory and the room to maneuver on that front is even smaller. Hence, it was no surprise that the SNB also kept the policy setting unchanged. The policy rate and the interest on sight deposits at the central bank remain at -0.75%. Forex intervention is a key part of the strategy, with the statement repeating that the franc is highly valued and that the “SNB remains willing to intervene more strongly in the foreign exchange market.” The statement stressed that “The SNB’s expansionary monetary policy provides favourable financing conditions, counters upward pressure on the Swiss franc and contributes to an appropriate supply of credit and liquidity to the economy.”
Like the BoE, the SNB sees risks to the upside as well as the downside, but in the very near term the inflation projections have been cut, although the contraction in GDP this year is now assumed to be somewhat less pronounced than anticipated at the September meeting. The outlook will depend largely on virus developments, but the main assumption at the SNB is that “there will not be a significant easing in the containment measures in Switzerland until the spring.” Even with a recovery of 2.5%-3% next year, the recovery would remain incomplete. At the same time, very expansionary monetary policy has boosted mortgage lending and residential property prices to an extent that these markets look vulnerable and could pose a risk to financial stability further out.
Hence, it is a challenging situation that will force the SNB to keep a close eye on financial stability indicators. The confirmation that the U.S. now officially classes the SNB as a “currency manipulator” won’t deter the central bank from continuing to focus on forex intervention to try and keep the currency under control.
Norges Bank (Norway) also left policy unchanged at a zero percent setting. Governor Olsen said in the statement that “the sharp economic downturn and considerable uncertainty surrounding the outlook suggests keeping the policy rate on hold until there are clear signs that economic conditions are normalising.” Indeed, the policy rate forecast implies that the current rate will remain in place for over a year ahead, with a gradual rise from the first half of 2022. However, the new forecast “implies a somewhat faster rate rise than projected in the September 2020 Monetary Policy Report.” Against the prospect of vaccination programs being rolled out, the Norges Bank is sticking with the accommodative policy stance for now, while starting to eye the end-game. If developments proceed as planned, the same will hold for other central banks across Europe.
