Contrary to much press speculation ahead of Wednesday’s inflation report, Mark Carney the Governor of the Bank of England, distanced himself from the speculation that, despite the recovering economy, imminent interest rate raises are on the agenda. Unemployment may be continuing to fall, but in his view the gap between what the country is capable of producing and what it is producing (spare capacity) means inflationary pressures will remain subdued removing the need to increase interest rates. Before Wednesday’s speech, markets were pricing in March for the first rate rise, that moved out to April after the speech.
Despite the improving economic outlook and the possibility of increased monetary stimulus from Europe, China and Japan, the 10-year UK and US yield curves continue to flatten. UK 10-year gilt and US treasury yields, at 2.53%, are now trading back to the bottom of the year-long trading range. In spite of the recent strength in bonds, equities remain resilient.
As we pointed out in our outlook for the week ahead, Thursday is a big day in America for economic data. Traders and analysts alike will be glued to their desks for most of the day pouring over the data; sandwich shops in Canary Wharf will be doing a roaring trade. It almost feels every area of the economy is covered, inflation, industrial production, capacity utilisation, and housing as well as manufacturing indexes from New York and Philadelphia.
Asian markets will have their share of data to analyse, in the form of GDP and consumer confidence data from Japan. Depending how it comes out, the release may or may not increase speculation that the Bank of Japan could look to increase its monetary stimulus program in the near future.
Once again it will be interesting to see how equities and bonds react if the data is better or worse than anticipated. Does better data bring forward the possibility of rate rises and that’s seen as a negative for equities. If the data is weak do investors start to worry that economic growth despite the signs of improvement could be stalling, the flip side to that is rates to stay lower for longer.
As we pointed out yesterday, we have been in an extended period when both bond and equity prices have been rising. Anecdotal evidence continues to point to equity investors remaining cautious, which does bode well for the longer term, but with the Vix at the bottom end of its trading range and bond prices rising a little caution may be warranted in the short term.