Geopolitical tension back in the driving seat – weekly update 16 April

A look back over macroeconomic and market events for the week ending 13 April 2018. Geopolitical tension was back in the driving seat, with risk assets generally drifting higher through the week. There are several data points of note due out this week, particularly mid-ranking economic data from the UK and China. US earnings season also steps up a gear, which could help markets re-focus on fundamentals.

Global politics were driving the markets again

Global politics were again driving markets with the focus shifting to Syria where the apparent release of a chemical weapon by Syrian government forces (which is backed by Russia) triggered a significant but isolated military response from the US, France and the UK. This is the latest development that is inflaming tensions with Russia, on top of the spat relating to the poisoning of a Russian ex-spy and his daughter in the UK and alleged interference with western democratic processes.

In response, there have already been a number of diplomatic expulsions as well as US sanctions on key Russian entities. This caused Russian equities to fall almost as much as 10% on Monday (MSCI Russia returned -9.56% in local currency terms) with the currency down more than 10% versus the US dollar by midweek, although both slightly recovered later in the week.

Conversely, potential trade frictions appeared to ease last week with more conciliatory messages coming from the US and China. Both suggested a deal can be done that doesn’t involve fresh tariffs (including the bilateral ones threatened but not yet implemented), as well as the possibility of the US re-engaging with the Trans-Pacific Partnership (TTP) and further apparent progress on the North Atlantic Free Trade Agreement (NAFTA).

In what has become a worrying sign of the times, much of the movement in the main markets has been determined by the latest tweets from Donald Trump. Although with US earnings season now underway, we should hopefully see fundamentals re-exerting themselves.

UK and Europe industrial activity was disappointing

UK and Europe industrial activity disappointed, rebounding less than expected. In the UK, Industrial Production growth for February was 2.2% year on year (yoy), up from a downwardly-revised 1.2% in January but short of the 2.9% expected. In the Eurozone, Industrial Production grew at 2.9%, below the 3.5% expected, but it did come with a significant upward revision for the January reading, which was upgraded from 2.7% to 3.7%.

While these data are disappointing, there are potentially mitigating considerations such as the poor weather that characterised the first quarter across Europe and overall we are not yet seeing a convincing trend. However, we will be watching related data closely, especially in light of some of the cooling momentum we have previously highlighted.

US CPI inflation was in line with expectations

US CPI inflation for March was in line with expectations, rising 2.4% yoy from 2.2%. Core CPI, which strips out the volatile elements of food and energy, rose 2.1% (as expected, from 1.8% previously). Markets largely ignored the news.

More broadly, commentary from Central bankers, as well as the most recent Federal Open Market Committee (FOMC) minutes, suggested rate setters are less concerned about short-term headline numbers and are more focused on the potential impacts of the tax cuts (economically positive in the short-term) or an escalating trade war (economically negative).

Last week’s other events

• In Japan, the Eco Watchers Outlook survey index slipped from 51.4 to 49.6 (51.0 expected). Core Machine Orders rose 2.4% yoy in February from 2.9% previously, and ahead of flat expectations, Bank Lending (excluding Trusts) growth slipped from 2.1% to 1.9% yoy
• Chinese imports grew 14.4% yoy in US dollars in March, from 6.3% previously and ahead of the 12.0% expected. Exports fell -2.7% from 44.5% (11.8% expected). CPI inflation cooled from 2.9% to 2.1% yoy (2.6% expected)
• In the UK, the British Retail Consortium reported like-for-like sales growth of 1.4% yoy (from 0.6%, -0.3% expected)

The markets

Risks assets drifted up on the week, while core sovereign bonds were generally slightly weaker and oil hit fresh highs.

One-month performance of major asset classes in sterling terms

Equities

US equities led the main equity markets higher over the week, with the S&P 500 index rising 2.0%. UK equities were up 1.3% and equities in Europe (excluding the UK) rose 1.1% as measured by the MSCI indices. In Japan, the TOPIX returned 0.6% while the MSCI Emerging Markets index rose 1.0%.

Bonds

UK 10-year gilt yields drifted up 4 basis points (bps) on the week to close at 1.44%, US 10-year Treasuries rose 5 bps on the week to finish at 2.83% and the equivalent German bund yields were up just over 1 bp to 0.51%.

Commodities

Oil strengthened through the week, boosted by geopolitical concerns. Brent crude oil broke through the US$70 per barrel mark to end the week at US$72.58 per barrel, the highest level since late 2014. Gold also gained some strength to finish at US$1,346.20 per ounce while copper barely changed ending the week at US$3.07 per lb (from US$3.06 the previous week).

Currencies

Sterling was stronger across the board, appreciating 1.0% against the US dollar and 1.4% against the Japanese yen, which was the main weakness. Sterling finished at US$1.42, €1.15 and ¥153 on Friday.

The week ahead

There are a couple of data points to watch out for next week. On Monday US Retail Sales are released (0.4% month on month (mom) from -0.1% expected). This is followed in the early hours of Tuesday morning with the latest batch of Chinese data including the first-quarter GDP estimate, Retail Sales and Industrial Production – see details below. UK releases include Average Earnings on Tuesday, CPI inflation on Wednesday and Retail Sales on Thursday – again, details are below. The daily breakdown is as follows:

Monday: Ahead of US Retail Sales in the afternoon, we will also have the latest UK House Price from Rightmove out in the morning. In the afternoon the US will release the Empire Manufacturing reading and Business Inventory levels as well as Retail Sales (covered above).

Tuesday: As covered above, we have the latest batch of data releases from China. The first-quarter GDP is expected to have cooled from 1.6% to 1.5% quarter on quarter, leaving the yoy rate unchanged at 6.8%. Retail Sales are forecast to have increased from 9.4% to 9.7% yoy in March, while Industrial Production is forecast at 6.3% from 6.2% yoy. In terms of the UK employment report, Average Weekly Earnings are expected to have increased from 2.8% to 3.0% yoy (three-month average), while unemployment is expected to be unchanged at 4.3%. Tuesday will also have the latest ZEW economic surveys for the Eurozone and US Industrial Production for March (forecast to have slowed from 1.2% to 0.4% mom).

Wednesday: Overnight we will have the latest Japanese trade data. The UK CPI inflation is forecast to remain unchanged at 2.7% yoy, with the Core measure expected to have increased from 2.4% to 2.5%. Later in the day, the US Federal Reserve releases its Beige Book of anecdotal economic reports.

Thursday: UK Retail Sales growth is forecast to have accelerated from 1.5% to 1.9% yoy, while data in the afternoon will focus on the US with Consumer Comfort and Leading Index data due out.

Friday: It’s a quiet end to the week with only Japanese CPI inflation (0.9% yoy expected from 1.0%) and Eurozone Consumer Confidence of note.