Data surprises and intensifying political pressures – weekly update 24 September

A look back over macroeconomic and market events for the week ending 21 September 2018. UK inflation and retail sales were stronger than expected, whilst there was disappointment from the PMI numbers in the US and Eurozone amid signs of a continued cooling of momentum. This week is all but certain to see another 25 basis point increase in US interest rates as well as the highly anticipated Italian Budget proposal.

Positive surprises from the UK

UK Inflation and Retail Sales both surprised on the upside. CPI inflation rose from 2.5% year on year (yoy) to 2.7%, against expectations for a fall to 2.4%. Similarly, Core CPI inflation – which strips out the more volatile elements of food and energy – rose from 1.9% to 2.1% (1.8% was expected).

The driving elements were admittedly the more fickle components, including travel fares, recreation prices and apparel, and the consensus among economists is still that inflation will fall back towards the 2% target.

However, with strong Retails Sales growth last week (the 3.3% yoy reading, from an upwardly-revised 3.8%, was well ahead of the forecasts for 2.3%) and strengthening wage growth, there is a risk that wage-push inflation could become entrenched, which would have an impact on the monetary policy outlook.

Negative US and Eurozone PMIs

There were negative surprises in the Eurozone and US Purchasing Manager Index (PMI) numbers. Eurozone Manufacturing PMI fell more than expected, down 1.3 points from 54.6 to 53.3 compared to expectations for a marginal fall to 54.5. Weaker export sales were mainly to blame, but there was also weakness in the new orders number, which fell to a two-year low, whilst the employment measure indicates greater caution in hiring strategies.

The Eurozone Services PMI was marginally better than expected, picking up from 54.4 to 54.7 (no change was expected), leaving the composite figure only slightly down from 54.5 to 54.2 (again, no change was expected).

Across the Atlantic, the US Manufacturing PMI from Markit rebounded more than expected, from 54.7 to 55.6 (55.0 was expected), helping to isolate the previous fall and redress some of the differential between the readings from Markit and the Institute for Supply Management that we highlighted previously.

However, it was the Services PMI that provided the shock fall this time, down almost two whole points from 54.8 to 52.9 (an increase to 55.0 was expected), with services firms reporting “intense cost pressures” as a reason to raise prices – a theme we’ve touched on previously, with wages rising quite notably and no productivity growth being a classic inflationary combination. Expectations and business optimism in both Manufacturing and Services also continued to deteriorate, which ties in with the cooling momentum that has been a theme we have been discussing in recent months.

Fresh tariffs on US$200 billion of Chinese imports

Whilst the timing was unclear, the announcement of fresh tariffs on US$200 billion of Chinese imports in the US last week was essentially inevitable with implementation happening over the weekend. China has responded, with tariffs on another US$60 billion of US imports now in the pipeline. Markets have so far taken the latest tariffs in their stride.

The flip side of running a trade surplus is that China ultimately has less scope to apply tariffs than the US. However, far from representing a potential end-point, the risk is that escalation may see the trade war broadening. As a starting point, this could mean China starting a currency war, reducing enforcement of sanctions on North Korea and limiting access for US companies in China.

Intensifying UK political pressures

UK political pressures have been intensifying after the Government had a tougher than expected time in Salzburg. UK Prime Minister Theresa May appeared to double down on her line that the choice was between her Chequers deal or no deal at all.

Rumours of a snap election are also back, and being seen as a potential route to breaking the Brexit deadlock, particularly given some of the perceived turmoil in the Labour Party, which will discuss the possible backing of a second Brexit referendum at the party conference this week. There will be plenty to watch in the domestic political front this week.

Other macro events

• The Bank of Japan reduced purchases of very-long dated bonds, though the Central bank marginally increased purchases at the short end. Some see this simply as the Central bank reacting to shifts in supply and demand, others as a stealthy move towards steepening the yield curve. CPI inflation rose from 0.9% to 1.3% yoy (1.1% was expected)
• Eurozone Consumer Confidence slipped from -1.9 to -2.9, worse than the -2.0 expected. Construction Output grew at 2.6% yoy, down from an upwardly-revised 3.0%

The markets

It was a good week for equities, and commodities also drifted higher. Sovereign bonds were generally weaker, though UK and Eurozone bonds rallied towards the end of the week.

Equities

It was a week of solid gains for equities. Japan led the way, with the TOPIX up 4.4% for the week. It was also a decent week for the UK, as the MSCI United Kingdom clocked up gains of 2.3%. Continental Europe (MSCI Europe ex UK) returned 1.7% whilst it was the US that lagged, as the S&P 500 returned just 0.9%. The MSCI Emerging Markets index returned 1.6%.

Bonds

Core sovereign bond yields moved higher on the week. US 10-year Treasury yields rose 7 basis points (bps) to close at 3.06% on Friday, whilst the yields on the equivalent Japanese Government Bonds rose a limited but nonetheless quite noteworthy 1.5 bps to 0.13%. In Europe, bonds initially sold off, but rallied towards the end of the week on the back of Brexit developments. 10-year gilt yields rose as much as 8 bps by the close on Wednesday, but were just 2 bps higher by the end of the week at 1.55%, and 10-year German bunds followed a similar trajectory, to end the week just 1 bp higher at 0.46%.

Commodities

The commodity complex was a little stronger on the week. Oil drifted slightly higher, with Brent Crude finishing at US$78.80 per barrel, whilst gold managed to return to US$1,200 per ounce on the nose by close on Friday, and copper rose to US$2.84 per lb.

Currencies

The euro and sterling both started the week on a stronger footing, with the yen particularly softer. Sterling sold off quite significantly on Friday following the latest Brexit developments, wiping out gains for the week and leaving the currency 0.99% weaker versus the euro. Sterling closed on Friday at US$1.31, €1.11 and ¥147.

The week ahead

There are more points of interest this week. The main event in terms of scheduled activity will be the US Federal Open Market Committee (FOMC) meeting on Wednesday, where markets appear certain (100% implied probability) that there will be another interest rate hike, though there will still be plenty of interest on the day as market participants look for relatively hawkish or dovish signals in the statement and press conference. Friday morning sees the Eurozone CPI print (2.1% from 2.0% yoy expected), and then on Friday afternoon the US PCE inflation reading – the Fed’s preferred measure – is released (2.2% from 2.3% yoy expected). There could also be some excitement on Thursday as the Italian Budget proposal is released. The daily breakdown is as follows:

Monday: The morning will give us German business expectations from the IFO as well as CBI sales trends in the UK. In the afternoon the US releases the Chicago Fed National Activity index and the Dallas Fed Manufacturing Activity index.

Tuesday: It’s a quiet day, with only the US Consumer Confidence measure from the Conference Board of note.

Wednesday: Aside from the FOMC meeting, we will also have Japanese Machine Tool Orders, US sales trends from the CBI and US New Home Sales to look forward to.

Thursday: As well as the Italian Budget proposal, the Eurozone Economic Confidence readings will be released in the morning, and then in the afternoon the US will report final revisions to second-quarter GDP numbers as well as Durable Goods Orders and the Kansas City Fed’s Manufacturing Activity index.

Friday: It’s a busy day for data releases on Friday. A minute after midnight, UK Consumer Confidence from GfK and the Lloyds Business Barometer will be updated, followed by Japanese Industrial Production and Retail Sales all before 1am. Chinese Manufacturing PMI from Caixin is also released early in the morning. Later in the morning, the final revisions to UK GDP growth are reported before Eurozone CPI, covered above (Core CPI is forecast to rise from 1.1% from 1.0% yoy). In the afternoon, as well as the PCE inflation measure, US Personal Income and Spending will be reported as well as the Chicago Purchasing Manager index.