Macroeconomic Indicators: Navigating the Pandemic

Viewers of BBC’s dramatisation of life in the City, Industry [1], may have been impressed by the enigmatic Harper Stern. Interning in Cross Product Sales, the American wins over clients with her pinpoint analysis of the US Treasuries market and exposure to forex markets. But one scene that stands out is a clandestine meeting with middle office regarding an unlicensed trade. Hungover and tired, Stern had booked a trade in the wrong currency, and was £50,000 in the red. Having crossed a Rubicon, she hopes for positive US employment figures to boost her trade and ends up in the black after better-than-expected figures, before adverse currency markets lead to a £270,000 loss.

The lesson here is that financial markets are normally dictated by macroeconomic indicators. And in turn, being on the right side of a particular news release is incredibly advantageous (especially if you realise profit, unlike in Stern’s case). As an effective gauge of the health of the economy and translated into corporate earnings, the broader economy is arguably the most important factor in determining valuations. Outside of the central bank largesse since the onset of the pandemic, macro indicators are a guide for interest rates, in term determining valuations from a forecasted cash flow perspective, and also setting rates in credit and bond markets. As such, macro indicators are financial harbingers.

Relativity and Forecasts

Data releases can be taken at face value. However, relativity, whether that be a change month-on-month (MoM) or year-on-year (YoY) change, or comparison to forecasts, is imperative for interpretation of figures. There are two main points regarding indicators and relativity. The first is that most indicators are predicted and forecasted by analysts and therefore results should be compared to forecasts, as well as previous readings in order to discern potential effects. Additionally, readings from developed countries and areas such as the USA and the Eurozone have a greater weighting on sentiment. Naturally so, given that the two are large developed economies and their economic performance is a good gauge for the world economy given how interconnected the global economy has become due to the growth and resilience of international trade and capital mobility.

Inflation

Inflation figures are released monthly, with two inflation figures often shown: month-on-month (MoM), and year-on-year (YoY), with YoY often used as the barometer for price changes. There is a multitude of price change indicators such as the GDP deflator, the Retail Price Index (RPI) and the Consumer Price Index (CPI). In the UK, CPI has overtaken RPI in recent years as the go-to gauge of inflation. Recent figures can be found via the ONS [2].

What does an inflation beat tell investors? In most cases, it is that the economy is overheating more than expected and interest rates are therefore likely to rise. Bonds should sell off due to an erosion of returns; the effect on equities is a little more complicated and affects growth and value stocks differently [3]. However, with the Fed committed to accepting inflation above its average target of 2%, as well as significantly low inflation and the presence of deflation in other developed economies such as the Eurozone, it seems like central banks will not commit to rate hikes until around 2023 given that the definition of an inflation ‘beat’ above its target rate has now changed.

Labour Market Indicators

Given labour being in derived demand in order to produce output in the economy, unemployment figures are key barometers for the state of the labour market, and more broadly, the macroeconomy. The US Bureau of Labour Statistics also releases data on job openings and wage growth, painting a picture of the labour market as a whole; all data releases should move in the same direction in terms of describing the labour market. Strong vacancy figures and low levels of unemployment should indicate an expansion of the economy, whilst a pullback in vacancies and increases in unemployment indicate a contraction. Note that wage growth should also contribute to inflation figures (although seminal studies such as one from the Riksbank suggest otherwise) [4].

The relationship between vacancies (job openings) and unemployment is shown via the Beverage Curve (below), which intuitively includes parameters such as labour market tightness to build a stylised model. More information on the model can be found here [5]. Given the above, bullish sentiment towards equities is discernible given the translation of a strong labour market into corporate earnings, boosting valuations. Depending on the corresponding inflation figures, the Treasury market should see a selloff.

Purchasing Manager Indexes

Perhaps the most closely watched indicator is the Purchasing Managers’ Index, produced by IHS Markit. Best described by the Balance as an economic indicator based on surveys on surveys of businesses in a given sector, the index is a weighted average of the sentiment of purchasing managers in the manufacturing and services industries. The two are also combined to create a composite reading. For any PMI release, a figure above 50 implies expansionary sentiment, whilst a figure below indicates that prevailing sentiment is indicating a contractionary environment. Given that the data is monthly, the reading is therefore seen as a monthly change, such that a value of 50 is seen as no change in sentiment from the previous month. Therefore, the PMI gives a more granular approach to analysing the macroeconomy, and its flash releases allow an earlier opportunity to gauge the health of the economy compared to other indicators. Poor readings – especially composite readings – often lead to selloffs in equity markets and falling Treasury yields.

PMI’s also allow for more detailed analysis depending on the country in question. For example, a poor Services PMI release for the UK, such as the reading last week, is bad news for both the UK economy and the FTSE 100, given most of its constituents operate in the services sector. Poor Manufacturing PMI readings for a country such as Germany could be translated into lower valuations for manufacturing exporters on the DAX 50.

Have Indicators Lost Their Importance?

Despite the use and importance of other indicators such as growth rates and house price indexes for financial market dynamics, the key indicator during the pandemic has been the stance of central banks regarding their quantitative easing programmes. Given the significant adverse economic impacts of Coronavirus, central banks have significantly increased their Treasury and gilt purchases, further corroborating the “lower for longer” argument regarding yields in fixed income markets. Therefore, the elasticity of yields to changes in indicators has become fractured since the onset of the pandemic. Data releases have caused market movements, particularly in equity markets, such as relatively positive US data [7] boosting stocks towards the end of the week ending Friday 22nd January. But the aggressive bond purchases that have characterised monetary policy in the pandemic. Monetary policy seems to have entered into a temporary new paradigm – any sign of a potential “taper tantrum” has been put to bed; yield curve control has been mooted. Given this, macro indicators will play a muted role in valuations and dynamics of markets (particularly in government bond markets) during the short- to medium-term.