Central Banks caused some confusion – weekly update 6 August 2018

A look back over macroeconomic and market events for the week ending 3 August 2018. Central Banks sowed some confusion in their latest monetary policy output, though both the Bank of Japan (BoJ) and Bank of England (BoE) effectively tightened policy. PMI data were disappointing, while the US non-farm payrolls came and went without impact. It’s a quiet week ahead, with most activity on Friday with the second quarter GDP from Japan and the UK and US CPI inflation due.

The Bank of Japan tweaked policy

The BoJ tweaked policy in what amounted to marginal tightening. Rumours had been circulating that a shift in policy was being considered, and on the day we got clarification that the Central Bank would give itself a bit more flexibility in its policy, doubling the band it allows around the zero-target for 10-year Japanese Government Bond (JGB) yields from 10 to 20 basis points (bps).

Although the band is symmetrical about zero, yields have recently been testing the upper bound, so allowing yields to rise further effectively amounts to marginal policy tightening. This is a point that initially confused markets and took the best part of a day to catch on.

After an initial rally, 10-year JGBs sold off on Wednesday, convincingly breaching the 0.10% threshold for the first time since 2016, though they subsequently stabilised well within the new range, at 0.12% by the close on Friday after the BoJ intervened with purchases to show it was still very much in the driving seat.

The Bank of England hiked interest rates

The BoE hiked interest rates by 25 bps to 0.75% in a move that was almost certainly ahead of time. Nonetheless, this represents only the second increase since the global financial crisis and the first move above the ‘emergency low’ 0.5% level introduced in the aftermath of the crisis (recall that the rate was cut a second time in the wake of the EU referendum, so the previous hike simply reversed that move). There was a minor surprise in that the vote was unanimous, with most market watchers expecting a few dissenters.

Despite this hawkish note, yields fell through the rest of the week, having risen ahead of the meeting. The main reason was, as usual these days, Brexit-related, with the upwardly-revised path for economic growth and interest rates caveated as being based on a relatively ‘soft’ Brexit. Concerns over Brexit were further heightened when the Mark Carney, Bank Governor, was a guest on the Today programme on BBC Radio 4 and highlighted that while a ‘no-deal Brexit’ wasn’t likely, the possibility was still “uncomfortably high” and would be a highly undesirable outcome. This was enough to give investors pause for thought and helped keep the currency down, though gilt yields were higher overall by the end of the week.

US non-farm payrolls came and went with little attention

US non-farm payrolls came and went with little fanfare. The headline number came in below expectations, with 157,000 jobs added in July (193,000 were expected), but came with an uplift of 59,000 to the estimates across the previous two months. The other key metrics came in exactly as expected, with average hourly earnings growth unchanged at 2.7% year on year (yoy), labour force participation unchanged at 62.9% and unemployment dipping 0.1% to 3.9%, though the underemployment rate fell further, from 7.8% to 7.5%.

The Purchasing Manager Index reports were disappointing

The Purchasing Manager Index reports were a source of disappointment, with the major reporting regions all falling short of expectations. The UK Composite PMI fell 1.6 points, from 55.2 to 53.6 – driven primarily by a fall in the Services PMI reading (53.5 from 55.1), while the Manufacturing reading was also a disappointment.

In the US, the Institute for Supply Manager PMI readings also disappointed: Manufacturing PMI fell from 60.2 to 58.1 (59.4 was expected), while Non-Manufacturing PMI was down over 3 full points from 59.1 to 55.7. China saw the official Composite PMI number slip from 54.4 to 53.6, dragged lower by both manufacturing and non-manufacturing sub-indices, and Japanese PMI Composite PMI slipped from 52.1 to 51.8. While these are not the most positive of developments, the absolute numbers are still generally indicative of continued steady economic expansion, with the US reading still particularly potent in the high 50s.

Last week’s other events

• The US Federal Open Market’s Committee (FOMC) meeting was uneventful – there were no changes and no press conference, with all the focus on next month’s expected interest rate hike. Other data from the US included PCE inflation which was unchanged at 2.2% with Core PCE also unchanged at 1.9% yoy. Personal Income growth was unchanged at 0.4% month on month (mom) as expected, while Personal Spending cooled from an upwardly-revised 0.5% to 0.4% mom, as expected
• UK Consumer Confidence from GfK dipped from -9 to -10 (no change was expected), while the Lloyds Business Barometer was unchanged at 29. The British Retail Consortium reported the Shop Price Index as falling -0.3% yoy in July (from -0.5% in June)
• Eurozone Economic Confidence dipped from 112.3 to 112.1 (112.0 expected). Within this, Services Confidence picked up from 14.4 to 15.3 (14.2 was expected), while Industrial Confidence slipped from 6.9 to 5.8 (6.7 expected). CPI inflation rose 0.1% to 2.1% yoy (no change was expected), with Core CPI rising 0.2% to 1.1% (1.0% was forecast). Retail Sales cooled from 1.6% to 1.2% yoy (1.4% was expected)
• Japanese Industrial Production for June contracted -1.2% from a year earlier, down from 4.2% in May and worse than the 0.6% growth expected

The markets

Markets generally moved sideways last week, with core sovereign bond yields picking up some noise going in to the Central Bank monetary policy announcements.

Equities

Movements were limited last week, with most major indices slightly negative overall. The US was the exception, where the S&P 500 eked out a 0.8% gain. In the UK, the MSCI United Kingdom index was down -0.6% with continental Europe (MSCI Europe ex-UK) just behind, down -0.7%. After a couple of weeks of relatively strong returns, the TOPIX fell -1.9% last week, while the MSCI Emerging Markets Index fell -1.4%.

Bonds

Given the elevated uncertainty going in to last week’s Central Bank meetings, core sovereign bond yields experienced relatively high volatility. 10-year US Treasuries and German Bund yields ended the week effectively unchanged at 2.95% and 0.41% respectively, with the US 10-year yield having briefly moved through the 3% midweek. 10- year UK gilt yields rose in the first half of the week before dipping in the last couple of days, but were still up 5 bps overall to finish at 1.33% on Friday, while the equivalent JGB yields ended up just 1 bp higher overall to 0.11%.

Commodities

The commodity complex was pretty quiet last week, with the assets we report on here all drifting a little lower. Oil slipped to US$73.21 per barrel, gold was down to US$1,214.90 per ounce and copper ended the week at US$2.76 per lb.

Currencies

The US dollar gained some strength last week as sterling and the Euro were both fairly weak. Sterling closed on Friday at US$1.30, €1.12 and ¥144.

The week ahead

It’s a subdued week ahead. Most of the scheduled data activity comes at the end of week on Friday, where we will have the first estimate of the second quarter GDP from the UK and Japan. In the UK, markets expect a modest pick-up from 1.2% to 1.3% yoy, while for Japan markets will be looking for confirmation that the -0.6% annualised reading in the first quarter was indeed an anomaly, with forecasts for 1.4% annualised for the second quarter. On Friday afternoon, the US will release CPI inflation data, with headline CPI expected to be unchanged at 2.9% yoy while the core measure is expected to remain at 2.3%. It’s also worth noting that sanctions on Iran, following the US withdrawal from the 2015 nuclear accord begin kicking in from Monday. The daily breakdown is as follows:

Monday: It’s a very quiet start to the week, with no data of note scheduled for release.

Tuesday: A minute after midnight, the British Retail Consortium reports Like-For-Like Sales (1.5% yoy from 1.1% expected). A short while later, Japan updates household spending, labour earnings and the Leading and Coincident Index economic gauges. Later in the morning, UK House Prices from Halifax are reported and in the afternoon the US JOLTS Job Openings and Consumer Credit numbers are out.

Wednesday: Another batch of economic data is released overnight from Japan. This time we will have Bank Lending and the Eco Watchers Survey results to look forward to. We should also see the latest trade data from China.

Thursday: Japan will report Core Machine Orders early in the morning, and we will also have the latest CPI inflation from China. Later, the European Central Bank (ECB) will publish its latest Economic Bulletin. In the afternoon, US jobless data are released and the Producer Prices Index latest readings.

Friday: It’s a busy end to the week. As well as the second quarter GDP from the UK and Japan, and US CPI inflation (covered above), we also have UK Industrial Production (0.7% from 0.8% yoy expected) released. The UK GDP release will also include relevant details such as business investment which could be of interest.