Reflation trade​​​​​​​

Covid-19 update
On the pandemic front, some very encouraging news came over the weekend with the Israeli health ministry announcing that chances to catch the virus have dropped 95.8% for individuals who received both doses of the Pfizer vaccine. Moreover, the health ministry added that the vaccine was 98% effective in preventing breathing issues as well as fever. Other positive news from Israel showed that the Pfizer vaccine significantly helped to reduce the spread of the virus as well as illness. On the matter, latest clinical data showed that the Pfizer vaccine was as much as 89.4% effective at preventing transmission. As a reminder, Israel has now administered roughly 7.4m doses accounting for 82.4% of the Israeli population. United Arab Emirates are the runner-up with 56.15% of the population vaccinated as of today followed by the UK which stands at 17.25m people vaccinated, ~26.73% of total population. UK Prime Minister Boris Johnson is expected to deliver an update speech today to unveil his roadmap out of the lockdown. Expectations are that schools are set to reopen from March 8th with outdoor activities allowed for small groups.

Yellen comments
Secretary of the Treasury Yellen called for a large stimulus package to help speed up the economic recovery. Yellen mentioned that the surge of federal spending could prompt a sustained rise in inflation but added that inflation has been very low for many years and the Fed could always rise rates. Yellen also said the White House will likely propose a second economic recovery package later this year that would include spending on longer-term investments like infrastructure, renewable energy, education, job training and research and development. The proposal would also include tax increases on corporations and wealthy Americans that would "phase in slowly over time." During his campaign, President Biden proposed raising the corporate rate to 28% from the current 21% (prior to President Trump's tax cuts in 2017, the rate was 35%).

Economic data
In the US, the IHS Markit services PMI rose to 58.9 in February, its highest level in almost six years. The indicator for US manufacturing slowed slightly but remained in expansionary territory. Separately, industrial production in January was 0.9% higher than in December, while consumer spending rose by 5.3% m-o-m. In Europe, the flash IHS Markit purchasing managers’ index (PMI) for manufacturing reached a three year high of 60.6 in Germany in February and rose in France (to 55.0) indicating that activity is expanding. But PMI figures showed services activity continues to contract in both the euro area’s largest economies. The composite PMI for the euro area overall was 48.1 in February.

China activity
As people were advised by the government not to make cross-province trips during the Chinese New Year holidays, travel activities in China dropped sharply by over 50% from the same period last year and by over 70% from 2019. However, this has led to strong local consumption. During the holiday week, retail sales (including restaurant services) rose by 28% y-o-y and movie box office revenues came in at Rmb7.8bn, the highest in history.

Earnings season
In the US, almost 84% of the S&P500 companies reported so far. From those, 78% of companies beat EPS estimates. EPS growth for these companies is running at +6% y-o-y, surprising positively by 18%. Overall y-o-y EPS growth moved into positive territory, after 3 consecutive quarters of negative growth. Most sectors are seeing an improvement, except for Energy and Airlines, which continue to print weak numbers. Topline growth in the US is +3% y-o-y, surprising positively by 3%. In Europe, more than 55% of the Euro Stoxx 600 companies reported with 68% of them beating EPS estimates. Q4 EPS growth is coming in at -16% y-o-y, and a much better -6% y-o-y ex Energy. At a sector level, Energy, Financials and Utilities are seeing very weak growth, while Tech fared better. Revenue growth is at -14% y-o-y, surprising positively by 1%, again heavily impacted by Energy. In Japan, 96% of Topix companies reported with 66% beating EPS estimates with an overall EPS growth at +12% y-o-y. Topline growth is down 1% y-o-y, and 62% of companies are beating revenue estimates.

Rates on the spotlight
The sell-off in sovereign bond markets gathered pace last week as investors stuck with the reflation trade, with US Congress focusing on passing the stimulus package in the coming weeks. The 10Yr US Treasury yield climbed to 1.31% last week, taking it above March’s highs of last year. The 10-year inflation breakeven climbed to a 6-year high of 2.25% before coming back down. In terms of rates expectations, markets are pricing in a steeper rate hike in 3-5 years’ time and a Federal funds rate closer to 0.4% in 2026. The slope of the 10-to-2-year part of the curve climbed to 118 bps – its steepest point since March 2017. In Europe, the 10-year German Bund yield climbed to -0.35%, its highest level since last June. The Bund yield remains very correlated to US Treasury movements. Italian sovereign debt has been outperforming this week as Draghi was confirmed as prime minister. A 10-year Italian bond offering attracted record investor demand this week, pointing towards high investor expectations for a successful Draghi government.