EC June 2021 Monthly

The US dollar, which confounded most observers by appreciating in the first quarter, has fallen broadly in April and May. The drivers, ironically, are the same: US rates and relative economic strength. Treasury yields rose sharply in Q1, and this helped the greenback recover from the accelerated slide in November and December 2020. However, they fell in April and did not get much traction in May. Spikes higher in yields, such as in response to the surprising acceleration of CPI to over 6% at an annualized rate in the first four months of the year, were short-lived.  

Federal Reserve officials say it is too early to consider tapering, and even the few that have suggested more willingness to discuss it, require a few more months of data. That means outside updated forecasts, no change in its stance should be expected from the June 15-16 FOMC meeting. A Bloomberg survey found a majority expect tapering to begin in Q4. The December 2022 Eurodollar futures contract has a 25 bp rate hike discounted more than a year before the majority of the Fed (11/18) thinks it will be appropriate.  

US economic data has not surprised to the upside as it did earlier in the year. Instead, three significant disappointments, non-farm payrolls, retail sales, and housing starts, marred April's reports and forced many economic models to temper projections of Q2 GDP. That said, the economy still appears to be accelerating after growing at a 6.4% annualized clip in Q1. Yet, at the same time, the pace of activity will likely peak in the middle two quarters of the year as the sugar-rush of fiscal spending begins to fade, and the surge associated with the re-opening fades.  

Meanwhile, the vaccine rollout in Europe has taken off, and economic activity is recovering quickly. Since mid-March, the ECB had stepped up its bond purchases, and there will be a vigorous debate at the June 10 meeting whether some reduction is in order. The rise in yields in recent weeks appears to have been driven by domestic rather than global considerations. Still, if the bond-buying pace slows, it may not be fair to call this tapering. It is more like what the Bank of Canada did last year, and the Bank of Japan and the Reserve Bank of New Zealand have done. For different reasons, there was a recalibration of the long-term asset purchases without the intent of reducing the stimulus.  

The European Union's fiscal initiative and budget have still not been ratified by all the members. Nor have all the spending plans been submitted. The recovery fund may not be up and running until well into Q3, and when it does disburse funds, it will be pro-cyclical in the sense of helping economies that are already rebounding. The UK contracted in January and February, but as the vaccine rollout improved, economic growth accelerated. Despite the Indian mutation of the pathogen, the UK is still on track from an economy-wide re-opening on June 21. The Bank of England reduced its weekly bond purchases intending to complete them by the end of the year.  

Japan is having a more challenging time of things. It is one of the few countries that is experiencing deflation (negative year-over-year CPI). Although the infliction numbers remain relatively modest, the formal state of emergency covering an area accounting for around 40% of GDP has been extended into June. A proper recovery may begin in Q3, but it may not be in enough time to help Prime Minister Suga, who faces a party leadership contest in September, and his decision to go forward with the Olympics (opening ceremonies July 23) is terribly unpopular. A decision is expected in June whether local spectators will be allowed to attend in person. The number of foreign attendees was cust in March from 600,000 to less than 70k.

Tax reform and coordination have been stymied at the OECD in recent years, largely but not solely because of the US intransigence. The US proposal for a 15% minimum corporate tax rate could be the basis of an agreement, and the first step is to reach a G7 consensus. Separately is the issue of the digital tax, which the US objects to because it singles out US companies. Some level of taxation for where sales are made applied to the largest companies seems to offer the possible basis of a compromise. Successful endorsement by the G7 finance ministers (June 4-5) and the heads of state summit (June 11-13) will also help US President Biden's domestic agenda. He seeks to unwind the 2017 corporate tax cut and lift the rate back to 28% from 21%, with many exemptions and breaks. The average effective corporate tax rate is seen several percentage points lower (Yardeni estimates 2020 effective corporate tax rates were slightly below 16%). 

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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