Original insights into market moving news

Week in Focus; week commencing 29th July 2019

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  • MON: UK Mortgage Lending and Approvals, Dallas Fed Manufacturing Index
  • TUE: Japanese Unemployment and Industrial Production, Australian Building Approvals, German Import Price Index and GFK Consumer Climate, Eurozone Consumer Confidence (F), German CPI, US Core PCE Price Index, Personal Income & Spending, Case-Shiller HPI, CB Consumer Confidence, Pending Home Sales
  • WED: Chinese Manufacturing and non-Manufacturing PMI, Australian CPI, German Retail Sales, CBRT Inflation Report, German Labour Market Report, EZ CPI, US ADP, Canadian GDP, Chicago PMI, FOMC Rate Decision & Press Conference
  • THU: South Korean CPI, Chinese Caixin Manufacturing PMI, EZ Manufacturing PMI (F), UK & US Manufacturing PMI, BoE Rate Decision, Minutes & QIR, US Challenger Job Cuts, Construction Spending, ISM Manufacturing
  • FRI: Australian CPI, Swiss CPI, UK Construction PMI, EZ PPI and Retail Sales, US NFP, Canadian Trade, US Factory Orders, Uni. Of Michigan (F)


A US delegation – including USTR Lighthizer and Treasury Secretary Mnuchin, and China Vice Premier Liu He – will travel to Beijing on Tuesday for the first trade face-to-face trade meetings between the two nations since talks collapsed in May. The chances of a deal have been downplayed. Indeed, there has been focus on the appointment of Zhong Shan, considered hawkish and an indication that China will pursue a tougher line in trade talks. Given all the noise, it is worth re-capping what both sides are hoping for: The US wants structural changes to the Chinese economy that allows American companies to compete fairly (Mnuchin has said that will alone help to address the trade deficit between the US and China), and it also wants China to enhance intellectual property protection, and put an end to Chinese subsidies that have contributed to overproduction of steel and aluminium. The US side has also called for the Chinese to eliminate JV requirements and other policies that effectively force technology transfers. On the other side, China has demanded that the US remove all tariffs on Chinese goods immediately; it wants the amount of goods it must purchase from the US be realistic and market-based; and it demands that its "sovereignty and dignity" be preserved, with any trade agreement/communique presenting both sides as equals. With the demands from both sides laid out in this manner, it is easy to see why a deal will be difficult to reach in the short-term. There have been signs of goodwill made by both sides recently: China has indicated it will up agricultural purchases from the US, while the US has agreed to make timely licensing decisions Huawei too. However, discussions are expected to be broad. On Friday, the NEC advisor Kudlow said that if the talks go well, he does not expect US President Trump to implement new tariffs on China, but if they do not go well, Trump will consider the tool.


The base case is for an ‘insurance’ rate cut of 25bps, taking the federal funds rate target to 2.00-2.25%; a 50bps move, though still a risk, does not seem to be a consensus view among voting officials that have given remarks recently. The immediate question will be whether the move is one-off ‘insurance’ purchase, or the beginning of an easing cycle. Much will depend on how convinced the Fed remains on global trade uncertainties’ impact on the US economy. An upbeat statement and remarks from Chair Powell may signal decreased probabilities of cuts at future meetings. Powell will also likely face questions on what impact a rate cut would have on financial stability given that the tone of recent tier-one economic data has been encouraging. The Committee will not update its economic projections this meeting. The consensus is not expecting asset purchases to be announced, but any hints of a change in balance sheet policy will be framed in the context of Powell’s assertion at the June presser that the Fed would always be willing to adjust balance sheet policy to help achieve its objectives.


The BOJ will likely keep settings unchanged, though markets assign a small probability of a cut. Some have suggested a wait-and-see approach might be prudent, given uncertainties around how far the FOMC will ease later in the week. Goldman Sachs says this is particularly so given the BOJ limited options for additional easing, while the current USDJPY level presents no urgency to cut rates. However, GS says that if the BOJ were to take action at the next MPM, it would likely come in the form of extending the timeframe in its forward guidance, which currently pledges to maintain the ultra-low rate environment at least through spring 2020. GS' base case is for the extension to occur at the October MPM, but the bank says it could be a close call between October and earlier, including July. The BOJ is also set to release its quarterly outlook report; GS thinks it will broadly maintain its economic recovery scenario, although it is likely to more sternly warn on downside risks, than it did in its April report.


Once again, the BoE is likely to maintain rates at 0.75% as the looming uncertainty posed by Brexit continues to bind its hands. Since the June meeting, the Conservative leadership race saw Boris Johnson appointed as PM. However, during the infancy of his Premiership, markets have been provided little in the way of fresh information as to how the negotiations between the UK and EU will play out in the run up to the 31st October deadline, other than Johnson being set to take a firmer line against Brussels than his predecessor, something which outgoing EC President Juncker and Chief negotiator Barnier have already pushed back against. However, despite all the bluster from the new PM, a ‘no deal’ Brexit is yet to become a consensus base case for markets with UBS recently stating that a general election, A50 extension or a ‘deal’ Brexit are all currently more probable outcomes. As such, the MPC are likely to continue to operate with caution as they wait for events to unfold, whilst ultimately reiterating their view that rate hikes “at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon”. In terms of recent data, UK CPI remained at 2.0% on a Y/Y basis with the core metric ticking higher to 1.8% from 1.7%; Pantheon Macroeconomics forecasts UK CPI will likely “fall a bit below the 2% target” in H2. From a growth perspective, monthly GDP for May printed at 0.3%, whilst survey data at the start of July showed deepening contractions in the manufacturing and construction sectors and a slowing in the pace of the expansion of the service sector, which saw IHS market conclude that Q2 GDP could contract by 0.1% vs. BoE forecast of flat. Recent commentary from policymakers has struck a cautious tone with MPC hawk Saunders recently suggesting that the BoE is not bound by forecasts implying rates hikes, whilst Chief Economist Haldane stated he sees the case for holding rates as ‘strong’. Nonetheless, more dovish members (historically), Vlieghe and Tenreyro have continued to state that they expect a gradual and limited tightening of policy. Alongside, the release, the latest round of economic projections in the QIR are set to reveal marginal increases to inflation forecasts as the lower implied rate path and depreciation offsets the impact potential of softer GDP expectations, stemming from lacklustre global growth prospects.


In the wake of last week’s ECB policy announcement and subsequent anticipated easing, Wednesday’s Eurozone inflation and growth metrics (1000BST) will be a key source of focus for investors as markets try to assess the extent of potential measures in September. As it stands, markets currently price in over a 90% chance of a 10bps cut to the deposit rate in September with ING raising the prospect of a deeper 20bps cut should the situation warrant such action (alongside other measures such as a relaunch of their QE programme and introduction of a tiering system). Consensus looks for headline inflation to slip to 1.1% from June’s 1.3% with the super-core metric forecast to fall to 1.0% from 1.1%. Ahead of the release, RBC notes that this month’s reading should see the removal of any lingering effects from the 2019 Easter holiday, whilst upcoming months will instead likely be guided by fluctuations in energy prices with petrol prices falling by 1% between June and July and as such could act as a drag on headline inflation. From a growth perspective, Q2 GDP is forecast to slow to 0.2% from 0.4% on a Q/Q basis with the Y/Y metric set to slip to 1% from 1.2%. RBC says that the temporary factors that underpinned growth in Q1 are likely to dissipate and instead industrial production and the construction sector could act as a drag.


The Street expects 160k nonfarm payrolls will be added to the US economy in July, following 224k in June. Fed Chair Powell looks at a three-month rolling average of headline payrolls, which after the upside in June, is running at a clip of 171k, and has been ticking higher for three straight months -- a consensus 160k in July would knock the three-month average back to 152k. This week, within the Conference Board’s July consumer confidence data, keep an eye on the ‘jobs plentiful’ and ‘jobs  hard to get’ differential; in June, it declined from a cyclical high, suggesting some cooling in labour market momentum. Also keep an eye on the ISM manufacturing report, where the employment sub-index has risen for three straight months, through June. Meanwhile, weekly claims data within the survey periods is unchanged on June, suggesting some stability. Analysts are also expecting the unemployment rate to decline by 0.1ppts to 3.6%. Average hourly earnings are seen rising 0.2% M/M, matching June’s pace; average wage growth Y/Y has managed to remain above the 3.0% mark for nine months, despite choppiness in headline payrolls. The FOMC will likely have eased rates two days prior to the payrolls report, and as such, any in-line report may have very limited action. 


The headline is seen rising by 1 point to 52.7 in July. The June report saw respondents express concern about US/China trade turbulence, potential Mexico trade actions and the global economy. Some of the regional Fed manufacturing surveys have rebounded in July, though Richmond is an exception. July's Markit manufacturing PMI, however, does not augur well, having fallen to the neutral 50.0 line, a 118-month low. Within the upcoming ISM data, there will be focus on the forward-looking new orders component, which fell 2.7 points to that neutral 50.0 mark in June, signalling an end to demand expansion. UBS says downside from these levels is generally associated with declines in US equities; the new orders 50.0 level also coincides with when earnings growth tends to turn negative, and when multiples account for the majority of the S&P 500's return, and the bank warns that as we move deeper into earnings season, slowing EPS growth could potentially weigh on P/Es, and drag equities down from their recent levels. As the ISM manufacturing new orders falls below its current level of 50.0, UBS expects a pivot toward risk aversion, similar to what was seen in the last two downturns.


US lawmakers have now passed the debt limit extension, and analysts say that passing now paves the way for increased Bills issuance. UBS says that doing so will restore the cash balance to USD 400bln, though adds that the Treasury has learned from lessons when ramped up issuance has caused distortions. UBS says the budget deal results in higher budget deficit forecasts in FY 2020 and FY 2021. In terms of the notes and bonds issuance sizes, UBS expects nominal coupon issuance to be unchanged. The bank does, however, see an increase in the 30-year TIPS reopening size. Additionally, it will be looking out for guidance on potential SFT-linked debt. Finally, the Fed’s purchases are a key variable, given they are a notable source of demand. “The Fed is set to end the runoff of its Balance sheet at the end of September. However, if they cut rates at the end of this month as we anticipate, that unwind will likely end in August.”


The official manufacturing PMI is expected to rise marginally to 49.6 from 49.4 in July. Weakness in recent months has been driven by domestic weakness and soft external demand. “We think that the manufacturing PMIs picked up in July, with domestic strength overshadowing external headwinds,” Capital Economics says. “Flash PMIs for developed markets suggests that momentum among China’s key trading partners has continued to weaken this month.” But despite this, it notes that industrial metals prices, which have a high correlation with Chinese manufacturing conditions, have recovered in recent weeks after declines last quarter. CapEco says that the modest improvements in the PMI would be consistent with further slowdown in Y/Y industrial output growth. The non-manufacturing PMI is seen paring a touch to 54.0 from 54.2. Retail sales data was tainted by a front-loading of auto sales as new emissions standards came into effect in June, and in July, auto sales are therefore likely o have normalised, putting some pressure on the services sector. This drag may be offset somewhat in the PMI data by firm construction activity, CapEco says.


The consensus looks for 0.5% rise in Q2 (prior was 0.0%); Westpac says this should lift the annual pace to 1.5% Y/Y from 1.3%; the bank notes that the June quarter tends to be seasonally soft; fresh fruit and vegetables prices will provide a drag, housing costs are slightly softer due to declining utilities and soft dwelling rents, there is also a seasonal decline in pharma, and autos prices are also set to fall again. Petrol prices will offer some upside. Westpac sees trimmed mean measure rising 0.33% in Q2 (1.5% Y/Y), and the weighted mean is seen rising by 0.3% in the quarter (1.1% Y/Y), indicating that inflationary pressures remain soft, and crucially, beneath the RBA’s 2-3% target range.


The Street looks for Canadian GDP to rise by 0.1% M/M in May, after the solid 0.5% M/M and 0.3% M/M seen in both March and April respectively. The March/April gains were driven by oil and gas production bouncing back following cuts around the end of the year, a theme that Canadian bank RBC does not expect to see continue in May. “The category should decline substantially, by 8% for non-conventional oil, due to maintenance and seasonal adjustment issues.” The bank says that there will be some offset from the manufacturing components, which is seen rising by around 1%. RBC also expect a flattish reading in May for the headline, and says that its Q2 GDP monitor is tracking 2.2% growth annualised, a hair beneath the BOC’s 2.3% projection made in July.