Geopolitics drove the markets – weekly update 14 August

Geopolitics drove markets last week

Tensions between the US and North Korea flared, fuelled by inflammatory rhetoric from the bellicose leaders of both countries. North Korea has stepped up its weapons-testing programme, prompting fresh sanctions against it and the inevitable outburst from its leader Kim Jong-un. One of the main differences this time, aside from the technical details of the weapons testing, is that US President Trump chose to bark back.

Markets have reacted with a distinct (if limited) risk-off move, causing equities to fall as core government bonds and gold rallied. Whilst we won’t downplay the seriousness of potential military conflict (let alone the nightmare of a nuclear exchange), we have seen these sort of events many times in the past, and the actual likelihood of action is minimal. The moves in the market are typical of this time of year, when news flow is thin and volumes are light – positioning investment portfolios for extreme left-field events is unlikely to prove a winning formula, and so most of our attention remains on the wider macroeconomic environment, quiet though that currently is.

Soft inflation numbers out of the US did nothing to rouse markets

Headline CPI rose 0.1% to 1.7% year on year, but this was below the 1.8% forecast. The core measure, which excludes energy and food, was unchanged at 1.7%. Energy detracted on the headline rate, as expected, given where oil prices are relative to last year, while food prices ticked up. Falling vehicle prices also had an effect. The lukewarm inflation environment recently may well temper some of the more hawkish market participants, at least until the effects of US dollar weakness start having a noticeable impact.

Last week’s other events

• Japan’s Leading Index increased from 104.6 to 106.3, slightly ahead of the 106.2 forecast, while the Coincident Index rose from 115.8 to 117.2, in-line with expectations. This was in contrast to the Eco Watchers Survey, where the measure of current conditions slipped from 50.0 to 49.7 (an increase to 50.2 was expected), while the outlook measure fell from 50.5 to 50.3 (51.0 was forecast). Machine Tool Orders fell from 31.1% to 26.3%
• Chinese Exports rose less than expected, up 7.2% year on year from 11.3% previously (11.0% was expected), but a slowing growth rate in Imports (11.0% from 17.2% with 18.0% expected) meant the trade balance increased from US$42.8 billion to US$46.7 billion (US$45.0 billion was expected). Inflation was slightly softer than expected, with CPI growth dipping 0.1% to 1.4% (no change at 1.5% was expected), while PPI inflation remained at 5.5% (5.6% was expected)
• UK house prices rose 2.1% compared to a year earlier (based on the three months to July), slightly down from 2.6%, and in line with expectations. Industrial Production for June beat forecasts, rising 0.3% year on year, from -0.2% in May and ahead of -0.1% expected. Manufacturing Production increased 0.6% year on year as expected (up from 0.4% previously), while Construction Output rose 0.9% year on year, an improvement on the -0.3% previously, but short of the 1.8% forecast
• US real average weekly earnings rose 1.1% year on year, as expected

The markets

A volatile week relative to recent history, with geopolitics and thin trading conditions driving a sharp, if limited, risk-off move.

Equities

Continental Europe led the main equity regions down over the week, with the MSCI Europe (ex-UK) losing -2.5%. The UK was just behind, as the MSCI United Kingdom shed -2.1%, while US equities fell -1.4% and the Japanese TOPIX index lost -0.9% (and was closed on Friday). The MSCI Emerging Markets index was down -1.7%.

Bonds

Core bond yields were down across the board. Ten-year gilt yields fell 12 basis points (bps) to 1.07%, whilst ten-year US Treasury and German bund yields were both down -9 bps to 2.19% and 0.38% respectively.

Commodities

Oil continued to range trade, with Brent crude holding above US$50/barrel. It was last seen at US$52.10/barrel on Friday. Gold was unsurprisingly stronger at US$1,287.70/ounce, while copper was also range bound, ending at US$2.91/lb.

Currencies

Sterling was somewhat weaker overall, while the yen gained against most major currencies. Sterling finished the week at US$1.30, €1.10 and ¥142.

1 month performance of major asset classes

The week ahead

There are a few interesting releases this week, though not much in the way of big ticket items. Early on Monday morning, China releases Retail Sales (10.8% from 11.0% year on year expected), Fixed Asset Investment (no change at 8.6% year on year expected) and Industrial Production (no change at 6.9% year on year expected). We have Q2 GDP releases from Japan and the Eurozone on Monday and Wednesday respectively, details below. There is a fair amount of data from the UK including Inflation data on Tuesday, Average Weekly Earnings on Wednesday and Retail Sales on Thursday, again, the numbers are below. Wednesday evening sees the FOMC minutes released from the latest monetary policy meeting with the same for the European Central Bank (ECB) the following day. There is also US Retail Sales on Tuesday and Eurozone CPI inflation on Thursday to look forward to. Going through the daily breakdown:

Monday: Japanese Q2 GDP is released early in the morning, and is forecast to have increased from 1.0% to 2.5% at an annualised rate. China releases Retail Sales (10.8% year on year from 11.0% expected), Fixed Asset Investment (no change at 8.6% year on year expected) and Industrial Production (7.1% year on year from 7.6% expected), also early in the morning UK time. Later in the morning, Eurozone Industrial Production growth is forecast to have slowed from 4.0% year on year to 2.8%, and there is nothing of note scheduled in the afternoon.

Tuesday: UK CPI is reported at 9.30am and is forecast to have risen 0.1% to 2.7% year on year in July, whilst Core CPI is also expected 0.1% higher at 2.5%. In the afternoon, US import and export price data are released along with the Empire State Manufacturing Index. US Retail Sales are expected to have improved from -0.1% month on month in June to 0.4% in July (for the Control Group).

Wednesday: The markets will be watching the UK employment data in the morning, with average weekly earnings expected to have risen 1.8% year on year for the last three-month period. Following this, the Eurozone reports Q2 GDP, with expectations for no change at 2.1% year on year. In the afternoon, the US reports Housing Starts and Building Permits before the FOMC minutes are released at 7pm UK time.

Thursday: Japanese trade data are out overnight, then later in the morning UK Retail Sales are expected to have slowed from 2.9% to 1.4% year on year in July. The ECB monetary policy meeting account is out at lunchtime, and in the afternoon the US reports Industrial Production (0.3% month on month from 0.4% previously) and Capacity Utilisation (76.7% from 76.6% expected).

Friday: It’s a quiet end to the week, with Eurozone Construction Output in the morning, and the University of Michigan sentiment survey results out in the afternoon being the only data of any potential interest.