US Treasuries – Defying inflation gravity.
US inflation continues to surprise on the upside. The June print displayed a 0.9% monthly change, twice the expectations and the highest reading of the past ten years. Annual inflation is now running at 5.4%. Transitory factors, such as used cars or commodities, still play an important role. In fact, right after the print, Powell has reassured the Congress that “transitory” is still the party line and any sign of inflation getting out of control could be rapidly tamed. Nonetheless, the June print has been the third upside surprise in a row, which means that also measures of “average inflation” start inching higher. Core components are starting being affected too. Shall another couple of prints materialize north of 4%, the patient stance of the Fed would turn gradually more untenable. In fact, the print has sparked a number of Fed speakers pointing to potential for early bond tapering, suggesting a lively debate within the FOMC. A patient Fed attitude justifies low front-end yield, but the current tightening of the long-end is more puzzling. Real yields are now very low even on a forward basis (with 10y at 1.3%, even 2.5% inflation would mean the curve prices a weak economy, while the US reopening is well ongoing). The gradual move higher of core inflation suggests inflation may actually turn stickier than expected. So while central banks may continue to keep real rates under control, nominal rates may have to correct further in 2H21, and seem unattractive at current levels.
China data – Unwarranted growth fears.
In China, second quarter data came out better than expected. Annual GDP growth slowed down to c.8% as expected, but quarterly growth has surprised on the upside. Most of the surprise stems from better than expected retail sales and consumer indicators, pointing to a relatively robust domestic picture. The prints are very good news relatively to what feared by markets last week. The surprise 50bp cut in RRR by the PBOC on July 9th suggested poorer numbers, and thus triggered fears on global growth. A slowing but solid Chinese domestic pictures remain supportive of global growth, and suggests that the PBOC attitude is very pre-emptive, further limiting potential downside on global growth. Trade data published this week have also substantially surprised on the upside, with exports showing a buoyant status of global demand and imports not contracting despite the second quarter shallow slowdown. We remain constructive on global growth and still believe that cyclical, reopening and energy/commodity sectors have the best upside.
Re-opening – Flying Delta.
Concerns about the Delta variant keep travel/re-opening relatively volatile. SXTP, the European Travel & Leisure index, is now at 250, 10% off the peak reached in May. We believe overall there are reasons to keep a constructive attitude. In countries with high vaccination rates, hospitalisation rates are growing but the hospitalised-to-cases ratio remains flat or is decreasing. Also, the vaccination rollout continues at a strong pace in Europe, and most Continental Europe will reach vaccination rates similar to UK and US. It is possible to see more stop-and-go policy in the restriction lifting as cases increase, but we think it is unlikely to see a massive tightening in the level of restrictions. Also, despite increasing cases the evolution of travel bans have been mixed. Some European countries restricted travel to high cases countries, but others have started easing bans, especially for vaccinated travellers. Overall we think persistent disruptions will be limited to countries with low vaccination rates, especially in Asia, and would look to fade dips in re-opening sectors in Europe and US.
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