UK economy’s bounce back in focus

At the end of last week, stock markets performed astoundingly well, and the FTSE 100 closed the week above 7,000 for the first time since February 2020. Wall Street also closed at record highs, both stocks and bonds rallied last week, with 10-year US Treasury yields falling to 1.58%, their lowest level since the end of March. This has led investors to ask two questions as we start a new week: 1, will falling yields signal a return to runaway tech valuations and a drop in the attractiveness of value stocks? And 2, does the fall in yields suggest that the Fed is regaining credibility and financial markets are finally starting to believe their message that lose monetary policy is here to stay until there is full employment, regardless of inflation running hot for a period of time? These are chunky themes to contemplate, not least because the prospect of rising US and global bond yields had dominated financial markets for the first three months of the year. 

Has the Fed won the credibility argument? 

Looking at bond yields first, those of you who studied economics will know that it’s unusual for record high stock markets that have risen 5% in the past 3 weeks, coincide with rising bond yields, especially when we see strong economic data - US retail sales and jobless claims were much better than expected last week. So, what is going on? Partly it’s due to the strong increase in bond yields during Q1, when you see the US Treasury market sell off so sharply (bond prices move inversely to yields), then you need to expect periods of reversal and volatility. Interestingly, Treasury notes have also risen – the 2-year Treasury yield has fallen – which is a sign that the financial markets are starting to take the Fed’s persistent dovish tone seriously after ignoring it and trading against the Fed for most of the first quarter of 2021. The decline in Treasury yields comes at an auspicious time for tech stocks. US tech giants report earnings in the next couple of weeks, with the bulk of earnings coming out the week of 26th April. However, Netflix reports results this week. The market will focus on first quarter subscription growth, which is expected to be a decent 6mn, however that is down from Q4 2020 and less than half the growth in 2020. Although the overall direction has been higher for Netflix this year, its stock has been volatile and struggled to gain upside momentum, along with many others in the tech sector. Thus, while these results are important, and while we expect to see some weakness in the stock price, especially if subscriber growth is weaker than expected as growing competition and the end of lockdowns in some areas of the world dents demand for in-home entertainment, the downside could be limited if Treasury yields across the curve continue to moderate. 

UK growth stats to determine fate of FTSE and pound 

The UK’s FTSE 100 index and FTSE 250 index have had a fantastic performance so far this year. The FTSE 100 has risen past 7,000 for the first time since February 2020. W hile recovering to its pre-covid high has taken some time, the formula for its success it clear to see: the increase in value shares. Value shares are the “old” sectors of the economy, for example energy, supermarkets, some bricks and mortar retail and airlines. Of course, these indices are not exactly old, and are innovating all the time, also many are highly digitalised, so comparing growth and value stocks is not as easy as saying that one is tech, and one is anti-tech. That is a lazy comparison. However, right now value stocks are outperforming, and this is filtering down the FTSE food chain, the FTSE 250 is close to a record high and has risen 2,500 points so far this year. Interestingly, the boost in stocks has only partially coincided with a stronger pound, however, since March, GBP/USD has fallen from its high above $1.41. However, this week could see the pound extend its recent recovery as we wait for employment data and inflation. Annual inflation is expected to increase to 1% in March, any increase could see a sharp increase in the pound as the market weighs up the high vaccination rates alongside rising inflation and tries to figure out what the BOE will do next. Thus, don’t be surprised if GBP/USD makes an attempt at $1.39 this week. Along with stable unemployment levels, the unemployment rate is expected to inch up slightly to 5.2%, and decent retail sales for March when the country was still in lockdown, and we could see a decent week for the GBP bulls. 

What to expect from the ECB 

This week we are also watching the ECB meeting on Thursday. The ECB has increased its bond purchases to nearly its upper limit at EUR 19bn per week, up from EUR 15bn a few weeks’ ago after the ECB extended its support at its last meeting. The question is, will that be enough, or does the ECB need to take action this week? We doubt it, however, we might see some talk around unjustified rises in bond yields, particularly in Italy, and also the recent reversal in euro weakness could also cause ECB President Lagarde to raise an eyebrow. Overall, a dovish ECB combined with decent UK data could trigger a return back towards £0.85 in EUR/GBP.