[Good Morning Stock Market] Accelerating US Economic Recovery... Increased Preference for Risk Assets

Rising Confidence in US Treasury Bonds Amid Economic Recovery Expectations
"Reduced Issuance Likely to Boost Risk Asset Preference"
Various Indicators Show Improvement... Short-Term Dollar Strength Anticipated
Corporate Capacity Utilization Still Weak... Focus on Whether Recovery Continues Through 2Q

[Image source=Yonhap News]

[Asia Economy Reporter Minwoo Lee] Expectations for U.S. economic growth have led to increased confidence in U.S. Treasury bonds, causing the yield on the 10-year U.S. Treasury note to fall to 1.58%. Analysts suggest that if the renewed preference for U.S. Treasuries limits the pace of rising bond yields, the bullish trend in risk assets such as stocks could be sustained for a considerable period.

◆ Seungbin Jo, Researcher at Daishin Securities= Last week, the 10-year U.S. Treasury yield continued its downward trend, reaching 1.58%. Key economic indicators, such as March retail sales which rose 9.8% month-over-month (expected +5.8%) and housing starts which surged 19.4% month-over-month (expected +13.5%), exceeded expectations, boosting optimism about economic recovery. Additionally, the March Consumer Price Index (CPI) increased by 2.6% year-over-year, indicating an accelerated pace of inflation. Compared to these, the decline in Treasury yields is somewhat unexpected.

This is interpreted as a temporary movement resulting from increased confidence in U.S. Treasuries linked to optimism about U.S. economic growth. The market consensus for U.S. GDP growth this year was 3.9% at the beginning of the year, below the global GDP growth forecast of 5.2%. However, with expanded COVID-19 vaccinations and President Joe Biden’s large-scale stimulus measures, the U.S. GDP growth consensus rose to 6.2%, surpassing the global GDP growth forecast of 5.8%.

As the effects of the Biden administration’s additional stimulus measures take hold, the U.S. economic surprise index is rising, unlike the Eurozone (19 countries using the euro), further raising expectations for U.S. economic recovery. Generally, Treasury yields rise during economic recovery phases because inflation risks increase and investor preference shifts from bonds to risk assets like stocks. However, the large-scale stimulus measures implemented due to COVID-19, which significantly increased Treasury issuance, also contributed to upward pressure on yields. If rapid economic recovery reduces the likelihood of further stimulus and Treasury issuance falls below expectations, investor confidence in Treasuries could rise again.

From the perspective of investors outside the U.S., current U.S. Treasury yields are quite attractive. The yield spread between the 10-year U.S. Treasury (adjusted for yen hedging costs) and the 10-year Japanese government bond stands at 1.01 percentage points (P). Similarly, the spread between the 10-year U.S. Treasury (adjusted for euro hedging costs) and the 10-year German bund is 1.02 P, both exceeding 1% for the first time since 2015.

We expect Treasury yields to maintain an upward trend due to abundant liquidity, global economic recovery, rising commodity prices, and large-scale Treasury issuance. However, attractive yield levels and accelerated economic recovery can enhance investor confidence in U.S. Treasuries. If renewed preference for Treasuries limits the pace of yield increases, the bullish trend in risk assets is likely to persist for a considerable time.

◆ Kwanghyuk Choi, Economist at Ebest Investment & Securities= Both U.S. housing starts and building permits showed a rebound. Considering that housing starts serve as a leading indicator of U.S. industrial production, concerns about a slowdown following the rapid rise in manufacturing indices are expected to diminish in the short term. The rebound in housing indicators, which had been a concern for U.S. economic growth, is likely to strengthen overall expectations for economic data.

In fact, the U.S. economic surprise index published by Bloomberg has entered a rebound phase from a slowdown and is outperforming the Eurozone surprise index. The difference between the U.S. and Eurozone surprise indices had declined since March last year, reflecting expectations for Eurozone economic growth, but since January, U.S. growth expectations have risen. The divergence between the surprise index difference and the dollar index earlier this year is believed to reflect psychological factors such as stimulus expectations following President Biden’s inauguration and the Eurozone’s lockdowns and vaccination rate disparities. Therefore, in the current situation where U.S. economic indicators are expected to rise further in the short term, expectations for a stronger dollar driven by U.S. economic strength are likely to outweigh the Eurozone’s base effects.

Remaining concerns include the fact that despite rapid increases in economic expectations and corporate earnings estimates, capacity utilization has not returned to pre-COVID-19 levels. This suggests that price increases have driven revenue growth from a demand and supply perspective. However, caution is needed as the gap between input costs and selling prices for manufacturing firms has reached its highest level since 2011. It is necessary to verify whether companies can pass on rising raw material and component costs caused by supply shortages to their selling prices.

◆ Byunghyun Jo, Researcher at Yuanta Securities= Although U.S. economic indicators show positive signs, capacity utilization and production sectors are less responsive than expected. Typically, when an economic shock akin to a recession occurs, both demand and supply contract. In a situation where supply contraction intensifies, marginal firms with low profitability are eliminated through industrial restructuring, and the excess demand arising from the gap between reduced supply capacity and recovering consumption leads to investment demand. Investment then stimulates employment and global value chains, creating a virtuous economic cycle.

The problem with the COVID-19 shock is that due to policy support and extremely low interest rates, restructuring did not occur. Despite a sharp drop in capacity utilization, U.S. bankruptcy filings through the fourth quarter did not increase significantly. This is not unique to the U.S. According to the International Monetary Fund’s (IMF) January World Economic Outlook (WEO), an analysis of bankruptcy trajectories during recessions in 13 countries shows that the current COVID-19 situation differs significantly from previous recessions.

The absence of restructuring, especially in traditional manufacturing sectors, may undermine confidence in the amplitude and continuity of economic cycles. This raises concerns about the sustainability of recovery momentum following the base effect in the second quarter.