HIGHLIGHTS OF THE WEEK
- Investor sentiment remained relatively upbeat this week on constructive economic data, positive earnings reports, and hopes for near-term pro-growth policies.
- Still, safe-haven assets remained in demand, supported by rising geopolitical tensions and anxiety over the first round of the French presidential election this Sunday.
- Overall, economic data has been coming in relatively healthy, both in the U.S. and other advanced economies, but the dichotomy between soft and hard data is hard to miss. This is particularly the case for the U.S. where survey data surged while hard data suggest that economic growth largely fizzled out in the first quarter. Having said that, some convergence appears to be in the offing.
HARD AND SOFT DATA BEGINNING TO CONVERGE
Market sentiment remained relatively sanguine this week. Equities in the U.S. were supported by a string of positive earnings reports and hopes for near-term pro-growth policies. Treasury Secretary Steven Mnuchin indicated that tax reform is “pretty close,” helping lift spirits of investors who in recent weeks began to question the Trump reflation trade. Sentiment was also supported by robust growth in China at the start of 2017, with the economy growing by 6.9% (y/y) during the first quarter. Oil prices tanked this week on a large build in gasoline inventories in the U.S. while the dollar remained range bound – neither helped nor hurt by this week’s FOMC speeches from across the hawk-to-dove spectrum, with George, Rosengren, Kaplan, and Kashkari expressing their views prior to the blackout period which begins on Saturday. Generally, safe-haven bonds remained in good demand, with long-term Treasury yields hovering around 2.2% or nearly 40 basis points lower than their mid-March nadir.
The bid for safe assets is at least partly related to rising geopolitical tensions on the Korean Peninsula and in the Middle East. There is also plenty of anxiety over the French election, which has been further heightened after yesterday’s terrorist attack on French police. Polls suggest that a populist candidate, whether Le Pen or Mélenchon, is in good position to make it through to the second round but unlikely to clinch the runoff election. And even if so, there is still a long-road ahead before any referendum on the EU is even considered (see our French election preview).
Populist candidates have been boosted by weak economic growth and high unemployment in Europe. But, the economic data has been coming in better as of late. Reports this week confirmed the constructive data flow. Inflation advanced by a decent 1.5% (y/y) in March, while both consumer confidence and Eurozone PMIs surprised to the upside. At 56.7, the preliminary April composite PMI suggests growth carried into the second quarter after a good start to the year. Having said that, any survey data should be taken with a grain of salt, given the increasingly diverging performance of hard and soft indicators recently.
The hard-soft split is perhaps nowhere as apparent as in the U.S. where measures of consumer and business confidence surged while economic growth appears missing, with first-quarter tracking a meagre 0.5%. However, data released this week suggests that some convergence may be in the offing. Both the Philly and Empire indexes, which track activity across the Mid-Atlantic region, pulled back from their lofty levels recently (see Chart 1), while initial claims and housing activity remain very healthy – home sales reached a decade high in March as permits and starts continued to grind higher.
How exactly the convergence will manifest will be of utmost importance both for Fed policymakers and investors alike. Many among the FOMC expect to raise rates twice more this year. But, should the soft data weaken and converge closer to what the hard indicators are suggesting, two more hikes may not be an achievable target. On the other hand, should hard data trend higher, the Fed may be more anxious to raise rates, and may even begin the process of reducing their large balance sheet.
Michael Dolega, Senior Economist
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