The aggressive sell-off seen in global bond markets during the week has taken most of the attention, leading to cascading effects across other corners of the markets. The message from officials from the Federal Reserve this week was that rising bond yields were a sign of confidence in the economic outlook in the US with the vaccine roll-out expected to pave the way for very strong GDP growth forecasts to be realised over the next couple of years. And this is where the impact of the Fed's shift to its average inflation targeting regime comes in, with Chair Jerome Powell reiterating during his testimony to the Congress this week that policy will not be tightened preemptively, with the current pace of asset purchases ($120bn/mth) to be maintained until its maximum employment and inflation objectives are met. One interpretation is that with the Fed remaining committed to its very accommodative stance amid an improving outlook, the power of its forward guidance on policy is being enhanced and the response in bond markets reflects this. That said, the pace of the move can unsettle, particularly given that it is inflation-adjusted (real) rates driving bond yields higher, which can lead to tighter financial conditions. Fed Vice Chair Richard Clarida delivered a similar message to Chair Powell on policy, noting that a return to pre-pandemic levels of output was still some time away, and the speech from influential Fed Governor Lael Brainard gave an overview of the range indicators that she views as key in forming assessments of the labour market, with the focus being on addressing "shortfalls" in employment from its maximum level. In terms of the data from the US this week, personal income lifted sharply in January (10.0%m/m) boosted by the receipt of recent stimulus cheques, prompting the personal saving rate to leap to 20.5% from 13.7%. This came alongside a 2.4% rebound in personal spending after a weak outcome in the month prior (-0.2%). Meanwhile, the core PCE deflator (Fed's preferred inflation gauge) ticked up to a 1.5% annual pace.
Over in Europe, officials from the European Central Bank have taken a more cautious line in response to the steepening in yields. Given the ECB's emphasis on favourable financing conditions, President Christine Lagarde noted in a speech that it was "closely monitoring" the moves in longer-term bond yields for signs that could be flowing through to higher rates for businesses and households. Comments from the ECB's Executive Board member Isabel Schnabel took this a step forward by highlighting that higher real yields at such an early stage in the recovery from the pandemic crisis "may withdraw vital policy support too early and too abruptly" for an economy yet to get back on its feet. And then ECB Chief Economist Philip Lane emphasised the flexibility available to it through its PEPP program to address a tightening in financing conditions. In the UK, the latest data on the labour market reported that the unemployment rate had risen to a 5-year high of 5.1% in December, while employment declined by a larger-than-expected 114k over the final 3 months of the year. While the UK Government's furlough scheme has limited the damage of the pandemic, it has still been very significant.
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In Australia this week, the focus was on wages data and on partial indicators that will feed into next week's national accounts and specifically the GDP growth outcome for Q4 (preview here). With Australian Government bond yields rising sharply, including at the front end of the curve, the RBA recommenced purchases of 3-year bonds to drive yields down towards its 0.1% target. These purchases totaled $7bn this week, and this was in addition to its usual amount of purchases under its quantitive easing program ($5bn/wk). Thus this was the largest week for RBA bond purchases ($12bn) since early April in the initial phase of the pandemic (see chart of the week). This all provides plenty of interest ahead of the RBA Board's policy meeting next Tuesday.
Chart of the week
With the Board's recent guidance around the need for labour market conditions to tighten significantly before policy accommodation can be withdrawn, this week's Wage Price Index (WPI) data for the December quarter suggested this was some way off. While the headline WPI increased by more than was expected in advancing by 0.6% in the quarter, the annual pace held around record lows at 1.4% (reviewed here). Key to driving the rise in Q4 was temporary wage freezes and reductions coming to an end as the economy was moving into gear again, reflected by private sector wages growth outperforming the headline index in lifting by 0.7%q/q to 1.4%Y/Y. Notably, wages growth in professional services increased by 1.2%—its strongest quarterly rise in 8 years—to be up by 1.5% over the year. Some of the other industries heavily affected by the pandemic crisis such as construction, health care, retail and hospitality also saw faster rates of wages growth as restrictions were eased. But, overall, there was little to suggest that stronger wages growth would be sustained in a labour market in which spare capacity remains elevated despite the progress achieved over the second half of last year in reducing it from peak levels.
On this week's other data points, private sector capital expenditure came in well ahead of the consensus estimate in rising by 3.0% in the December quarter—its fastest quarterly gain in 8 years—but was still 7.5% down through the year with firms cutting back or shelving investment plans due to the uncertainty associated with the pandemic (reviewed here). Equipment investment was particularly strong (5.7%qtr), prompted by expanded tax incentives included in last year's Federal Budget to encourage firms to bring forward spending, as well as improving domestic economic conditions. Meanwhile, forward-looking investment plans for 2020/21 were upgraded by 4.8% on the level anticipated 3 months earlier, rising to $121.4bn. But capital expenditure is on track to fall by around 7% compared with the previous financial year, highlighting the impact of the pandemic on business investment. Australian construction activity posted a 0.9% contraction in Q4 in a weaker-than-anticipated outcome (reviewed here). But the main story is the emerging upswing in the residential construction cycle that is being driven by the tailwinds of policy stimulus, such as the Federal Government's HomeBuilder grants, state government incentives for first home buyers and low interest rates. Private sector residential construction activity advanced 2.7% in Q4, with detached new home building up 3.4% and alteration work lifting 3.6%.
