Is Good Data Now Bad News?
It is possible that good data could be interpreted as bad news for the U.S. stock market at least in the near-term as strong economic data, especially on jobs, could prompt the Fed to unwind earlier.
In contrast, good news may remain good news for international stocks, because the rise in inflation has not been seen globally and central bankers in Europe and Japan are not under pressure to communicate tighter policy.
Strong growth may favor international stocks over U.S. stocks, tempered slightly by the near-term risk of a stronger dollar. Investor worries over a global economic stall may be held in check since, unlike at the start of the pandemic when all central banks rushed to loosen policy simultaneously, tightening will be a much more gradual and independent process, with the ECB and BOJ much slower to withdraw stimulus.
The June 16 Fed meeting and its accompanying Summary of Economic Projections were the focus of last week's news, featuring a dot plot that points to potential rate hikes by end-year 2023 and discussion commentary about upcoming QE tapering . The market interpreted the Fed’s message as a sudden lurch toward unwinding its extraordinary policy stance in response to a strong economy and soaring inflation. Investors reversed this year’s reflation trend in the markets:
- stocks posted their worst week since February,
- value stocks underperformed growth stocks,
- international stocks underperformed U.S. stocks,
- the dollar strengthened with its best week since September 2020
- gold had its worst week since March 2020.
With the sudden change, investors may be wondering: has good news become bad news? Weak economic data in 2020 implied easier monetary policy from the Federal Reserve and acted as a boon to stocks as investors began to price in a turnaround. But, now, strong data may suggest tighter policy is forthcoming and weigh on stocks as investors begin to expect an eventual downturn. We believe that the U.S. economy can withstand tighter monetary policy and continue to produce solid growth after achieving “escape velocity” and may no longer need the boost from the Fed’s extraordinary stimulus. But, in the near-term, it is possible that good data could be interpreted as bad news for the U.S. stock market should strong economic data—especially on jobs— prompt the Fed to unwind earlier and faster.
Where good is still good
In contrast, good news may remain good news for international stocks. The rise in inflation seen in the U.S. has not been reflected globally. This means that, unlike the Fed, the European Central Bank (ECB) and the Bank of Japan (BOJ) are not under pressure to communicate tighter policy.
Inflation rates have diverged:
- In the United States, core consumer price inflation (CPI) has accelerated to an above average +3.8% in May from a year ago.
- Eurozone core CPI returned to its five-year average of just +1.0%.
- In Japan, core CPI has fallen below average and negative at -0.3%.
The rise in inflation has not been global
Source: Charles Schwab, Bloomberg data as of 6/18/2021.
Reviewing the past five years, the pace of core CPI in these regions has differed, with the U.S. averaging 2%, Europe 1% and Japan 0%. But the divergence in direction has taken place only in the past few months. The reason for the divergence may be related to the timing of the recoveries. The U.S. was a leader in the vaccination rollout, which helped to unleash pent up consumer demand as the economy reopened this spring. Europe and Japan lagged on vaccinations with broad re-openings anticipated months later, as the summer gets underway. Also, U.S. ports have been more congested than those in Europe or Asia, resulting shortages of key products also helped push up U.S. prices in the second quarter. And, the easy inflation comparisons to a year ago seen in March and April in the United States that lift inflation won’t be seen in Europe and Japan until the fourth quarter.
As the third quarter unfolds, pent up demand may soon push up consumer prices in Europe and Japan. Year-over-year growth comparisons may ease in the U.S. along with supply chain bottlenecks and commodity prices. Perhaps these conditions will lead to some degree of global convergence in the pace of core inflation, although a significant gap in inflation rates, as seen prior to 2020, may remain, with higher inflation in the United States.
The central bank policy rate in the U.S. is zero (between 0.0% and 0.25%). It is negative in Japan at -0.10% and in the Eurozone at -0.50%. The impact of the policy rate on the economy is determined by the inflation rate environment; a policy rate below the pace of core inflation fosters lending and growth while a policy rate above the pace of core inflation hinders borrowing and the economy. When we adjust nominal policy rates for inflation using core CPI, the real policy rates, reflecting actual costs, are estimated around -3.7% in the U.S., -1.5% in the Eurozone, and +0.2% in Japan. This suggests policy rates in the U.S. are much more stimulative than those elsewhere in developed economies.
Current Real policy rates (simple column chart)
Source: Charles Schwab, Bloomberg data as of 6/19/2021. Real Interest rates calculated using the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate.
With inflation running at or below-average and relatively less stimulative policy rates, the European Central Bank (ECB) and Bank of Japan (BOJ) are not under pressure to communicate tighter policy. That means good economic data is likely still good news for these stock markets.
Although overshadowed by the Fed meeting a week later, the ECB met on June 10 and said as much. The ECB policy statement confirmed that net purchases under its pandemic QE program over the third quarter “to continue to be conducted at a significantly higher pace than during the first months of the year.” The ECB also upgraded their growth and inflation outlook. The head of the ECB, Christine Lagarde repeatedly referenced a “steady hand,” in the press conference, implying that the ECB will be patient in the face of an improving outlook. She also placed emphasis on the difference between economic conditions in the Eurozone and the U.S., reiterating that inflation risk is a lot lower in the Eurozone than in the United States and that the ECB is still far from its inflation target. Her statement underpins the view that ongoing stimulus is likely, regardless of the pickup in growth and potential rise in inflation.
Following the Fed meeting, the BOJ held its meeting on June 18th and stated it will continue all monetary policy stimulus, including yield curve control, asset purchase programs, and forward guidance. Their “Special Program to Support Financing in Response to COVID-19”, which includes commercial paper and corporate bond purchasing, which was due to expire at the end of September was also extended an additional six months. This commitment to ongoing stimulus came along with the BOJ statement that "Japan’s economy has picked up as a trend.”
Policies are beginning to diverge between those of the Fed and other major central banks. The ECB and BOJ are reassuring the market through ongoing stimulus, whereas the Fed seems to be preparing the market for a future announcement regarding the tapering of bond purchases to begin later in 2021 and end sometime in 2022, followed by rates hikes in 2023.
This divergence suggests three takeaways. First, at least in the near-term, it is possible that good data could be interpreted as bad news for the U.S. stock market (especially on jobs), yet good data may remain good news in international markets. Second, strong growth may favor international stocks over U.S. stocks, tempered slightly by the near-term risk of a stronger dollar. And, third, investor worries over a global economic stall may be held in check since, unlike at the start of the pandemic when all central banks rushed to loosen policy, tightening will be a much more gradual process and some like the ECB and BOJ may not join in anytime soon.
Michelle Gibley, CFA®, Director of International Research, and Heather O’Leary, Senior Global Investment Research Analyst, contributed to this report.