Financial markets roundup for the week of April 23: The Bank of Canada reduced its weekly bond purchases while forecasting a rate hike in the second half of 2022, becoming the first major central bank to offer forward guidance on policy tightening. While the European Central Bank continues to maintain its accommodative stance, a growing number of central banks have begun to prepare for the inflation outlook in the United States, making investment sentiment increasingly nervous. U.S. President Joe Biden’s plan to propose a bigger-than-expected increase in capital gains taxes briefly weighed on stocks and weighed on sentiment for risky assets. But with the latest robust economic data showing the recovery taking hold, investors are already looking ahead to next week’s Federal Reserve rate decision and a slew of big data releases.
On the epidemic: India reported 332,730 confirmed cases on Friday, the world’s highest number of infections in a single day for the second day in a row, and 2,263 more deaths in a single day. Hospitals have been overwhelmed by the rising number of patients, causing severe shortages of oxygen, intensive care beds and respirators. Sky News noted that the UK travel ban is in effect for tourists from India, and British and Irish citizens returning from India will still be allowed to enter the country, but must be quarantined in a government-designated isolation hotel for 10 days. Canada and the United Arab Emirates have suspended passenger flights to India for 30 days, and Singapore has tightened restrictions on Indian travellers. This suggests that the differentiation of epidemics in many places will lead to an uneven global economic recovery.
FX markets: The dollar was briefly supported by strong economic data, although the greenback remained broadly on the defensive, in part because fears of inflation-driven US interest rate rises receded as Treasury yields retreated.
Stock market: Joe Biden’s proposal for a big capital-gains tax increase hurt sentiment in the short term, but the market gradually decided that aggressive tax increases would be hard to come by because Congress is so close. As a result, some of those fears faded, combined with strong earnings reports across the board, and the U.S. stock market, while still in the red for the week, has recovered most of the week’s losses.
Commodities markets: Sustained weakness in the dollar has helped gold this week try to break through the $1,800 level, which could help it move toward $1,900. Analysts are optimistic about the near-term future of gold prices, even though the current push against $1,800 has been unsuccessful. The positive outlook is largely driven by two drivers — the recent Bitcoin sell-off and President Joe Biden’s plan to nearly double the capital gains tax rate for the wealthiest Americans. On the other hand, the US economy got off to a strong start in the second quarter and a brighter outlook and stimulus measures helped boost demand as restrictions were eased and vaccines rolled out, but the resumption of outbreaks in countries including India will continue to limit oil price performance for the time being.
Upbeat economic data ahead of blockbuster data stoked optimism
New claims for state unemployment benefits fell to 547,000, the lowest level in more than a year, according to a Labor Department report on Thursday, compared with analysts’ estimate of 617,000. Separately, the Chicago Fed’s national activity index rose to 1.71 in March from -1.2 in February.
Meanwhile, the U.S. Markit Manufacturing PMI and the U.S. Markit Services PMI recorded 60.6 in April, both record highs. In the U.S., sales of new homes totaled 1.021 million at an annualized rate in March, the highest since September 2006.
Chris Williamson, chief business economist at market research firm IHS Markit, said the U.S. economy got off to a strong start in the second quarter, and the upturn was broad-based as easing restrictions and the introduction of vaccines, a brighter outlook and stimulus measures helped boost demand.
Mr Biden’s proposal to increase capital-gains taxes is scary but sobering too
Biden’s proposal would mean some investors could face a federal tax rate as high as 43.4 percent, Bloomberg reported, citing people familiar with the matter.
“Some of the highest capital gains taxes in the world hit 30 percent. Most are around 20%. This is more than that. Add in Biden’s infrastructure spending plan and we could see stagflation, “Pavilonis said. Stagflation is a period when inflation is combined with a decline in GDP.
Biden’s plan is affecting stocks, cryptocurrencies and, most importantly, the dollar, which has an inverse relationship with gold.
“The dollar doesn’t seem to like a lot of the policies coming out of Washington, including the new capital gains tax hike proposed by the Biden administration,” said Everett Millman, a precious metals expert at Gainesville Coins. Moreover, one of the next big initiatives is infrastructure spending. “Both of these factors are weighing on the dollar, which is positive for gold.”
But economists at Goldman Sachs expect Congress to pass a watered-down tax increase. The capital-gains tax rate is likely to rise only to about 28%. Meanwhile, only about 25% of the U.S. stock market is subject to capital-gains tax for domestic investors, according to UBS, and even fewer accounts make $1 million a year. As a result, they argue that even if capital gains taxes are raised, the overall impact on stocks should be limited.
Canada’s central bank takes the lead in turning eagle watershed to come?
On Wednesday, the Bank of Canada announced its March interest rate decision, becoming the first G7 economy to explicitly move forward its guidance to 2022.
The Bank of Canada left its benchmark rate unchanged at 0.25 percent after the meeting, but cut its weekly bond purchases to C $3 billion from C $4 billion and signaled a resumption of rate hikes as soon as next year. The Bank of Canada sharply raised its economic growth forecast for this year by more than two percentage points to 6.5 per cent, with inflation expected to move well towards its 2 per cent target by the end of 2022.
‘The message from the Bank of Canada has rekindled some risk appetite,’ notes strategists at ANZ Research. ‘And risk appetite has extended to other commodity-linked currencies.’
But then the ECB left interest rates unchanged and said it would buy 20 billion euros of bonds a month under its asset purchase program, as before. There will be flexibility to buy bonds to prevent tighter financing conditions. The ECB said it would maintain its 1.85 trillion euro emergency bond buying programme (PEPP), which will continue until at least the end of March 2022, as previously.
At a subsequent press conference, European Central Bank President Christine Lagarde also said the recovery in global demand was supportive of the economy, but the rebound in inflation was due to temporary factors and underlying price pressures were low. Headline inflation is likely to pick up in the coming months, especially as market-based inflation continues to creep up gradually.
Ms Lagarde also said the US and eurozone economies were not in sync, and the ECB’s policies would not be in sync with the Fed’s. Negative interest rates are an effective tool for providing stimulus and the results of a strategic review will be published in the autumn. That gives investors some comfort.