We are taking a brief look outside of the U.S. this week just to see how other markets are faring so far in 2021. In Europe, the Euro Stoxx 50 index is up 3.29% on the year while the FTSE 100 shows U.K. equities up 2.63% so far this year. France’s CAC 40 is up 4.17% and Stockholm’s OMX index leads the major Europe indices – up 9.27% for the year.
As in the U.S., European equity indices are betting on a reflation trade. Certainly current conditions are still challenging. Europe is still on track to print negative growth in Q1 of this year, but as Europe gets its troubled vaccine schedule back on track, there is every reason to expect a strong second half of the year. Manufacturing PMIs have been rising even as the Services PMI counterparts have trending lower. As in the U.S., inflation looks to have made a comeback. Eurozone data show a 0.9% general rise in prices compared to negative numbers at the end of 2020. Some of that was helped by the expiration of a temporary tax cut in Germany at the end of the year. There is some talk of a cut in the ECB’s deposit rate, and indeed markets are starting to price that in, such that the best deposit rates that we see in Europe in the short term have diminished to -0.70%.
The tool that remains in the hands of the European Central Bank is the Pandemic Emergency Purchase Program (PEPP). This is the asset purchase program put together last summer to address weakness in the midst of the lockdowns. It was strengthened at the end of last year to go from €750 billion to €1,850 billion.
Asian stocks are generally high as well and frankly leading the way in bullish trends. Japan’s Nikkei is up 5.17% while Hong Kong’s Hang Seng index is up 6.86%. Clearly the experience of Asia with the pandemic is allowing it to move past the lockdown. For what it is worth, Mongolia’s stock market is up 72%! That is a bull market if I ever saw one.
Across U.S. borders, Canada’s primary index is up 5.40% so far this year while Mexico’s key market is up 6.63%. Latin America is otherwise VERY mixed with Brazil’s and Argentina’s indices down 3.13% and 7.86%, respectively. Chile’s stock market is up 13%, however.
Finally, among the biggest movers in the world this year are energy prices. West Texas Intermediate Crude is up 36% so far this year while Brent Crude is 34% higher in 2021. We have talked a lot this week about how that reflects strong sentiment for everyone getting back into cars and on airplanes. At the same time, this is an input cost for a lot of countries and companies, and if prices increase too far and too fast, it could endanger the global post-COVID party.
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This week's podcast is hosted by Yael Eisen-Avidan. She is joined by her colleagues on the FX desk -- Tomoko Iwakawa and Julia Allegretto -- in a special discussion connected to International Women's Day on Monday March 8. They discuss the role of how women in Japan affect investment decisions of many Japanese households as well as stories of their own.
One- to two-week view: The euro is expected to continue trading in its recent range. Euro value remains a function of EU growth prospects (employment data out this week), which in turn depend on the current COVID-19 situation. While the number of new COVID-19 cases has fallen, the slow pace of vaccinations (herd immunity projected in September/October in the EU versus June in the U.S.) means the relaxation of lockdown restrictions and full reopening of the economy will come after countries such as the U.S. and U.K. As such, European growth continues to lag U.S. growth (see contrasting PMI performance) on the back of differences in COVID-19 restrictions, the magnitude of fiscal support provided and proposed, and differences in vaccine distribution success. On the monetary front, European Central Bank (ECB) officials continue to take on a dovish bias. Given this, the global COVID-19 narrative and economic outlook continue to improve and the picture for growth in the eurozone looks better now than it did at the turn of the year.
Three- to six-month view: With the factors that pushed the euro higher in 2020 having faded or starting to fade, gains in 2021 should be harder to come by. Moreover, the prospect of more fiscal stimulus and a faster vaccine rollout in the U.S. relative to Europe increases the chances for a return of U.S. exceptionalism and U.S. growth that outpaces European growth. Near-term optimism on a recovery in global growth helps push the euro higher in Q1, but the single currency should dip into year-end as U.S. yields rise, the European Central Bank continues to fight deflation and market focus shifts to questionable domestic growth fundamentals. In essence, it is difficult to see a sustained euro rally without European economic exceptionalism and the prospects of ECB rate hikes.
One- to two-week view: Recent currency strength has been driven by relative vaccine outperformance and markets pricing out negative rate risks, but these factors are now mostly priced in, leaving the bias for continued range trading with downside risks. Prime Minister Boris Johnson released his reopening “road map” outlining how the government plans to ease lockdown rules over the coming four months. With the job market remaining under stress despite government aid, markets will be looking to the budget to provide clarity on how much fiscal support the chancellor is willing to provide.
Three- to six-month view: The U.K.’s vaccine rollout outperformance and resulting economic optimism has provided a boost to the pound. Compounding this support has been the message from the Bank of England that it is unlikely to impose negative rates. While the vaccination program is encouraging, there are reasons to remain cautious. The first reason is that the economy isn’t moving ahead of its peers but simply catching up to them. The second factor is the impact of vaccinations. While the relative pace of vaccinations will affect the relative trajectory of the U.K. economy over the next few quarters, it won’t impact the long-run sustainable economic trend rate, which is more relevant for the medium-term GBP. In this respect, Brexit, which has been overshadowed by the pandemic, has been and should continue to be an economic drag. This means that the U.K. economy will have to recover not only from its pandemic underperformance, but also from the damage done by the narrow trade deal, which is fundamentally bad.
One- to two-week view: USD/JPY has come under pressure due to the widening U.S.-Japan yield differentials, as overseas yields face increasing upward pressure while Japanese yields remain suppressed by yield curve control (YCC). Given this, expectations remain for the yen to range trade as it tracks the broad dollar trend. Markets are also waiting on the results of the Bank of Japan’s strategic review. Recent comments out of the central bank indicate that the basic framework of policy under yield curve control and negative interest rates would not be altered, but the parameters under which these two policies are operating were open to fine tuning. At present, the most likely outcome appears to be a relaxation of YCC with a strong commitment to further easing. To the extent that an extended state of emergency leads to a sharper deceleration in economic activity and BoJ dovishness, the yen will face depreciation pressure. To this end, the speed of vaccine rollouts, which recently started, remains important.
Three- to six-month view: The medium-term outlook is still biased toward a stronger yen. However, rising U.S. yields have pushed USD/JPY higher and represent the strongest headwind to further yen appreciation. Given this, it should be noted that U.S.-Japan real yield spreads still support a move toward 100 yen per U.S. dollar (USD) even if U.S. yields move somewhat higher. Regarding monetary policy, markets will be looking out for the results of the BoJ’s policy review due in March. If media reports are correct, the BoJ could signal the de facto end of YCC by announcing a wider trading band. An emerging point of discussion is the impact of Japan’s vaccine imports. Estimates put Japan’s vaccine bill at around $2 billion to $3 billion, or roughly half of Japan’s total trade surplus with the U.S. in February of last year. This could provide some support to USD/JPY, although this support is likely temporary.
One- to two-week view: An extension of several government COVID-19 benefit programs should keep the economy supported in the near term. Overall, continued policy support (Bank of Canada and Fed policy broadly aligned), the continued global recovery and vaccination efforts have improved the outlook for growth. A key risk factor to Canada’s economic recovery is the relatively slower vaccine rollout relative to its peers. However, faster vaccine rollouts and large fiscal stimulus in the U.S. should provide support to Canadian exports and investment activity. The upshot to a slow vaccine rollout in Canada is the potential for a quick bounce-back in the economy once inoculations gather pace and allow for restrictions to be lifted. The CAD remains susceptible to global risk sentiment, broad dollar moves and oil prices in the near term, but the view remains constructive.
Three- to six-month view: The medium-term CAD outlook remains constructive. While the USD has picked up some support, further CAD appreciation is supported by the Canadian economy’s proximity to the U.S. due to increased U.S. demand for Canadian exports. Moreover, the CAD should benefit from a move up in commodity prices as the global economy continues to recover. Notably, oil has been a strong performer on a year-to-date basis and the outlook remains bullish. On monetary policy, the BoC has adopted a more positive tone and laid down the parameters for eventual QE tapering, adding to the positive medium-term outlook. In essence, the bank has tied paring back policy support to the economy performing “in line or stronger” than the bank’s forecast—making the country’s vaccine progress something to keep an eye on. Finally there is the potential for federal elections this year, but the impact on CAD is likely modest and mainly tied to possible changes in fiscal policy.
One- to two-week view: Recent indicators show China’s economy continuing to grow. However, there has been a moderation in the pace of this growth and inflation. Nevertheless, relative economic outperformance, a current account surplus and relatively high yields form the base for a bullish view and support a continued drift lower for USD/CNY. Eventually, COVID-19 vaccine distribution will allow the rest of the world to close the growth gap, but for now China’s yield advantage and foreign investor inflows support further gains. While it has been reported that China is considering measures to allow greater outbound investments as huge inbound flows have led to steady yuan appreciation, expect policymakers to keep a close eye on domestic outflows. On the geopolitical front, China is looking at restricting rare earth mineral supplies to critical U.S. industries. Overall, the U.S. will take a more conventional approach to China, and expectations are for U.S.-China tensions to remain elevated as Biden retains a tough-on-China approach.
Three- to six-month view: The yuan’s year-to-date appreciation against the dollar index reflects supportive fundamentals and solid fund inflows. China’s export sector has outperformed, and while there is medium-term risk that a resumption in production in the rest of the world could undermine Chinese exports, risks for an immediate setback are limited. On the flow front, bond inflows remain solid and should continue given China’s relative yield advantage. Regarding the central bank, the People’s Bank of China has yet to signal any strong resistance CNY gains except for a continued relaxation of measures designed to control outflows. This implies that Chinese officials are not yet uncomfortable with recent currency appreciation.
One- to two-week view: Rising Aussie yields, commodity prices and hopes of a global recovery continue to provide support for the AUD in the near term.On a broader level, the RBA has signaled its intent to remain dovish with “very significant” monetary support provided for some time, as it will take years to meet its inflation and unemployment goals. The central bank meets this week and should reiterate its dovish commitment, and could step its YCC activities. Meanwhile, tensions between China and Australia continue to linger, but have led to only a limited economic impact thus far. However, Chinese economic activity, while growing, has started to show moderation on the margin and should impact Australian commodity export volume. Expect markets to continue to buy into any dips.
Three- to six-month view: Recent price action has been driven by strength in key commodity prices, with iron ore being a particularly important catalyst as prices continue to benefit from a rebounding Chinese economy and disruptions to supply chains outside of Australia. However, Chinese economic growth has started to moderate, and other producers are ramping up production. This is particularly important, as commodity prices are a key driver for the Aussie. Regarding monetary policy, the RBA announced an extension of its quantitative easing (QE) program. While history shows that QE has had a limited impact on exchange rates, it should still lead to a weaker AUD on the margin. As for trade, Australia-China trade tensions continue to linger but, critically, China is not expected to put restrictions on iron ore due to the lack of alternative supplies.
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