US equities were lifted by positive sentiment last week as the US-China ‘phase 1’ trade deal was inked in Washington. Macro data in the US dollar were very bullish as well. China also delivered some good numbers, even though the press focused on the fact that the GDP growth was the lowest in 30 years (not understanding that the Chinese economy is several times the size that it was decades ago).
Back in the UK, dismal retail sales put pressure on gilt yields and sterling, and markets raised their expectation of a Bank of England rate cut, as early as next week.
Technology and emerging market equities have been leading the market surge against a backdrop of lower government bond yields, which is an unusual combination.
The week ahead
Thursday: European Central Bank (ECB) Monetary policy meeting
New ECB president, Christine Lagarde’s first monetary policy meeting was a relatively quiet affair as she started her new reign by making no major changes to monetary policy. Lagarde’s most significant input was her decision to start a strategic review of the ECB’s current policies, as well as a commitment to continuously monitoring these. This week’s meeting is likely to be similarly uneventful with Lagarde firmly in wait-and-see mode for the time being. Despite the lack of policy action, the post-meeting press conference will be closely watched as investors are still trying to establish the new president’s principles and beliefs, and subsequently the likely direction that European monetary policy will take.
Friday: Preliminary US Markit Manufacturing PMI
Most forecasts for 2020 assume that with central banks across the globe cutting interest rates – and trade tensions abating – there will be an upturn in manufacturing activity and therefore global growth. The belief is built around the view that a rebound in manufacturing activity will lead to a rise in business confidence and capital expenditure, which in turn will boost consumer confidence and household spending. While there are early signs of this taking place, one area where the trend is looking a little shaky is in the USA. The two leading manufacturing surveys, the ISM and Markit have seen a marked divergence in their respective growth forecasts, with the ISM survey predicting a sharp contraction while the Markit survey is expecting a revival in manufacturing fortunes. A divergence of this magnitude is rare. Should the Markit survey continue to point to an expansion in activity this week then it should provide investors with enough confidence that the ISM reading will play catch-up as the year progresses. This will allow investors to maintain their relatively positive outlooks for the year ahead.
Friday: Preliminary UK Markit Manufacturing PMI
In the UK, there has been little evidence of the expected ‘Boris Bounce’ – the idea that the Conservative’s decisive victory in the General Election will create an expansion in UK economic growth due to the reduction in political uncertainty. Retail sales disappointed over the festive period and forward-looking confidence surveys have pointed to further weakness ahead. Investors will be hoping for signs of the ‘bounce’ in this week’s manufacturing sentiment survey. However, with manufacturers believed to have significantly stockpiled in anticipation of a ‘no-deal’ Brexit, signs of a rebound this week might be a little premature. Nevertheless, further disappointments in the manufacturing reading may not fully deter investors’ positive outlook for the UK economy, as a significant amount of the boost is set to come from a change in fiscal policy. All eyes are therefore on the extent to which the government loosens the purse strings in the Budget (11 March) as this will be key in determining the likely boost to the economy.
Bank of England to cut rates?Dallas Fed President, Robert Kaplan said that the Federal Reserve’s (Fed) monetary policy is contributing to “elevated risk asset valuations”. The expectation for Fed rate changes this year is decidedly schizophrenic, with a 15% probability of a rate hike next week vs a 58% chance of a cut by the end of the year.
The Bank of England, however, is fostering more unanimity amid market participants, with a 70% probability of a rate cut next week and 85% by the end of the year, due to the poor economic statistics stemming from the UK. The People’s Bank of China left its one-year and five-year rates unchanged.
A plethora of good numbers helping sentimentSurveys: The NFIB small business optimism index fell from 104.7 to 102.7. The Empire State manufacturing survey rose from 3.3 to 4.8. The Philadelphia Fed survey soared in January from 2.4, which was already revised upwards, to 17.0. The question about this volatile series is whether the downtrend from the peak in early 2017 has been broken.
Inflation: The import price index rose from -1.3% to +0.5% year-on-year in December, whilst the export price index recovered somewhat from -1.2% to -0.5%. The CPI (consumer price index) rose from 2.1% year-on-year to 2.3% in December, although the more meaningful core CPI excl. food and energy remained at 2.3%. The PPI (producer price index) rose from 1.1% to 1.3% but the core gauge excl. food and energy was lower at 1.1%, from 1.3%.
Sales and employment: Retail sales had a good month in December, excl. autos rising from 0% to 0.7% with the control group (like for like) rising from -0.1% to +0.5%. Initial jobless claims fell from 214K to 204K, getting closer to the all-time low of 193K last April. Housing: MBA mortgage applications surged 30.2% during the week, following a 13.5% rise previously. The NAHB housing market index was a tad softer at 75 vs 76. Housing starts, however, surged 16.9% to the highest number in 13 years. Building permits were subdued, falling 3.9% but still in a rising trend.
Poor data pushing markets into the hands of the Bank of England
Growth: Industrial production year-on-year fell 1.6% in November vs 0.6% previously. Construction output was more buoyant, up 2.0% vs a drop of -0.3%. The index of services rose 0.1% on a 3-month/3-month basis in November vs 0.3% the prior month.
Prices: Inflation in December fell to a three-year low, at 1.3% for the CPI (consumer price index), down from 1.5% and the RPI (retail price index) stable at 2.2%.
Housing: The house price index picked up from 1.3% to 2.2% in November. The RICS house price balance in December was better at -2% vs -11% the prior month.
China’s numbers are good, despite what the media saysChina: GDP widely mentioned to have been the lowest in 2019 for 30 years, not realising that the Chinese economy is now several times the size it was then. 6% for 2019 with 6.1% in Q4. Industrial production edged up from 6.2% to 6.9%, retail sales were unchanged at 8%, property investment softened a little at 9.9% vs 10.2% and fixed assets excl. rural (investment) was up 5.4% vs 5.2% (all YoY). The surveyed jobless rate rose from 5.1% to 5.2%. Exports rose 7.6% year-on-year and imports surged 16.3%.
Money supply expanded, highlighting monetary support for the Chinese economy. The broader gauge, M2, rose from 8.2% year-on-year to 8.7%.
Japan: Machine tool orders were slightly less depressed, at -33.6% year-on-year compared to -37.9% the prior month. The eco watchers survey was steady, with the current level rising from 39.4 to 39.8 but the outlook falling from 45.7 to 45.4. The tertiary industry index (services) rose 1.3% in November from -5.2% previously. Industrial production was down 8.2% year-on-year, almost in line with the previous month. Capacity utilisation fell 0.3%.
Is the auto sector recovering?
The eurozone trade balance fell from €24bn to €19.2bn. The current account also eased from €35.8bn to €33.9bn. Industrial production was still negative, but less at -1.5% vs -2.6%. Construction output rose 1.4% in November, vs 0.9% previously. The eurozone CPI (consumer price index) stayed at 1.3% year-on-year for the core reading. The EU 27 car registrations surged from 4.9% to 21.7% in December.
The lessening of Mid-East tensions is weighing on oil prices. The bellicose speech by the Iranian leader on Friday did not move crude. A more recent decision to close down two oil facilities in Libya boosted prices over the weekend.