Walking and Talking

Although Jay Powell and other Fed spokespeople reiterated their intention to maintain an accommodative stance despite the looming fiscal push, US 10-year yields ended last week another 10 basis points higher, bringing the overall rise so far this year to more than 50 basis points. Real yields continue to drive the sell-off, market-derived measures of inflation expectations having peaked on 16 February. This market reaction is probably not surprising since none of the Fed speakers attempted to push back against the rise in yields, attributing it to the improvement in the macro outlook.

In the previous issue of Macrocast we opined that the ECB could not afford to be passive given the magnitude and speed of contagion on the European bond market from the US, at odds with the cyclical conditions in Europe. Governing Council members engaged in robust verbal intervention last week, explicitly weighing against an ill-timed tightening in market conditions. Brokers reported an increase in the pace of the PEPP, suggesting the ECB is “walking the talk”. This is justified in our view. Everywhere in the developed world a rebound in the growth rate of new Covid cases is being observed, but in the Euro area this creates a specific risk given the slow start of the vaccination programme. There, the trough in economic activity may not have been reached. The case of Italy is telling. The country started to re-open on a regional basis last month, but the re-acceleration in the circulation of the virus is now triggering more stringent restrictions again in the economically crucial regions of Lombardy and Piedmont.

A key issue at the current juncture is whether the rise in market interest rates will force fiscal authorities to reconsider the magnitude of their stimulus programmes. There is no sign of this in the US. Although the Biden administration will probably be unable to get its steep rise in the minimum wage to USD15 per hour – some good news on the inflation risk side – it seems the package will not land too far from the administration’s initial target of USD1,900bn. The UK is the only G7 country where the rise in interest rates is explicitly used to justify concrete fiscal stabilization plans, with in particular a significant albeit gradual hike in the corporate tax rate. We will monitor the market reaction to this first experiment. It is possible that investors will focus more on the country’s overall macro strategy than on public deficit projections. Raising corporate tax might not be the most obvious choice for post-Brexit Britain.