The markets started last week in thrall to the myriad soundbites coming out of the Davos World Economic Forum with a few economic statistics drawing attention, such as a huge rise in UK business optimism, which boosted sterling. By mid-week, the coronavirus infection in China had a dampening effect on market mood and was mostly responsible for Hong Kong and Chinese markets falling sharply before the onset of the Chinese New Year on Friday night. Risk appetite was subdued worldwide, with government bond yields falling and oil prices collapsing. Over the weekend, the announcement of a massive rise in the number of infections and deaths from the coronavirus has set the markets for a difficult week ahead.
Over a trading week shortened by the US Martin Luther King Day holiday on Monday, global equities fell, with Hong Kong and Asian markets leading on the way down, and Japan most resilient. Government bond yields continued on their year-to-date slide with gilt yields anticipating a possible rate cut by the Bank of England. Sterling was a little stronger, in particular against the euro. Oil prices slumped 7% whilst gold acted once again like a defensive investment.
The week ahead
Monday: German IFO Business Climate Index (January)
We have noted how the German economy has struggled for momentum since the trade tensions between the US and China put downward pressure on global export markets. This forward-looking business sentiment indicator hit a trough in August of last year and has been on an upward trend ever since, and in many ways is reflective of the upturn in the fortunes of the manufacturing sector. We expect this confidence to improve gently as a function of business sentiment, given the recent thawing of trade tensions.
Thursday: Bank of England Monetary Policy Committee
There is no doubt that Brexit uncertainty has cast a cloud over central bank policy making, indeed outgoing BoE Governor Mark Carney has been quick to point this out in previous meetings. With the UK economy stalling since the referendum result, the central bank has broadly sat on its hands but the newly found certainty created by the new domestic political situation following last month’s election has forced through a change in view. More recently two members of the MPC and the Governor have spoken about potential rate cuts ahead of this week’s meeting. Market expectations of a rate cut are now over 80% yet the economic data is showing a sharp bounce post-election (sometimes referred to as the ‘Boris’ bounce). This week’s meeting will be eagerly anticipated with investors not quite sure on what outcome to expect.
Thursday: US GDP (Q4 2019)
Donald Trump spoke highly of the US economy at Davos last week, perhaps unsurprisingly in an election year. There is some merit to his view as the US economy has dragged global demand along at a point when the rest of the world were suffering with their own idiosyncratic difficulties. Economists expect US growth in the last quarter of 2019 to remain at 2.1%, as it was in the third quarter, although the survey spread is quite wide at 2.9% for the highest estimate and 1.5% for the lowest. Hiring momentum has slowed and trade tensions have started to bite as US business pared back investment. Given that the Federal Reserve cut interest rates throughout 2019, the cheaper cost of capital should support both business and consumers, which in turn can support the broader economy. If the data release is materially lower than the anticipated 2.1%, the market may be spooked into thinking this is the start of a growth scare.
The numbers for the week
Bank of England rate cut expectations are falling
The Bank of Japan (BoJ) left interest rates unchanged throughout, slightly increasing its GDP growth forecast and reducing its inflation forecast.
Likewise, the European Central Bank (ECB) left its deposit rate unchanged at -0.50% (also its main refinancing rate at 0.00% and its marginal lending facility at 0.25%) and agreed to keep the pace of monthly buying at €20bn of bonds. Incoming ECB President Christine Lagarde did not give any details on the ECB policy rethink which is expected to take all of 2020 to complete. The few economic pointers were not market movers (“we see signs of a moderate increase in underlying inflation”, “downside risks are somewhat less pronounced”). Climate risks were on top of the agenda for the ECB Governing Council.
The markets are still split on the expectation for the US Federal Reserve (Fed) rate movements, with a 12% probability of a rate hike later this week but a 75% probability of a rate cut by year end.
The Bank of England was expected to cut rates later this week, but the percentage probability has fallen as economic data in the UK have improved, and now stands at 55%.
Confusing surveys but housing and jobs are still driving the economy
Housing: MBA mortgage applications fell 1.2% during the week, after a whopping +30.2% the previous week. The FHFA House Price index rose 0.2% in November vs. 0.4% the prior month. Existing home sale rose 3.6% during December vs. -1.7% in November.
Employment: Initial jobless claims rose a little from 205K to 211K, below estimates, whereas continuing claims fell from a spike of 1768K to 1731K, again below estimates.
Surveys: The Leading Index fell 0.3% in December, vs. +0.1% the previous month.
The Kansas City Fed manufacturing activity index improved somewhat from -8 to -1, better than expectations. The Markit manufacturing PMI fell from 52.4 to 51.7, bucking the trend of other manufacturing PMIs worldwide, but the services PMI improved from 52.8 to 53.2.
Austerity is definitely over and surveys are soaring
Employment: Looking better under the bonnet. The claimant count rate at 3.5% in December was up from 3.4%. Average weekly earnings were unchanged at 3.2%, ex-bonus at 3.4%, down from 3.5%. The ILO unemployment rate was stable at 3.8%, but the employment change over 3 months/3 months surged to 208K in November vs. 24K the previous month.
Government spending: Central government finances ballooned, with the Public Sector Net Borrowing Requirement soaring from £9.5bn in November to £16.6bn in December.
Surveys: CBI Trends total orders rose from -28 to -22 and selling prices eased from 6 to 2. CBI business optimism, though, surged from -44 in October to +23 in January, a quantum leap in confidence. The Markit/CIPS manufacturing PMI rose sharply from 47.5 to 49.8, almost at 50 level between expansion and contraction. The services PMI, however, really soared, from 50.0 to 52.9.
Confusing surveys, but the ZEW and PMIs are clearly bullish
ZEW survey: Germany ZEW survey improved and beat estimates: the current situation at -9.5, was up from -19.9, expectations at 26.7 from 10.7. For the eurozone as a whole, the expectations soared from 11.2 to 25.6.
Other surveys and PMIs: Manufacturing confidence in France rose somewhat, from 98 to 100, but the 98 was revised down from 102 and the 100 missed the estimate. Likewise, French business confidence fell from 105 to 104. The French production outlook indicator remained at -5 and so did the business survey overall demand at 3. Eurozone consumer confidence was unchanged in January at -8.1. The Markit manufacturing PMI improved in the eurozone, from 46.3 to 47.8, with France rising from 50.4 to 51.0, Germany from 43.7 to 45.2. The services PMI was softer and mixed at 52.2 vs. 52.8, with Germany rising to 54.2 from 52.9 but France falling to 51.7 from 52.4.
Has Japan turned the corner?
Hong Kong had its rating downgraded by Moody’s Investor Services to Aa3 from Aa2 due to the lack of proper response to the unrest. This, together with the onset of coronavirus in China, caused a large drop in Hong Kong shares and in Chinese domestic equities. The announcement of an extended New Year’s holiday in China as a result of soaring infections and deaths will undoubtedly hit the markets when they re-open next week.
Real Economy: The trade deficit (adjusted) was higher at ¥102.5bn (US$935m) vs. ¥91.9bn (US$838m) with exports falling 6.3% year-on-year in December and imports down 4.9%. More importantly, Japanese machine tool orders are still stuck near the bottom of their range, down 33.5% year-on-year in December vs. -33.6% previously.
Surveys: The leading index was a tad softer at 90.8 vs. 90.9 and the coincident index down from 95.1 to 94.7. The one bit of silver lining seemed to be the all industry activity index improving from -4.8% to +0.9% in November.
The Jibun Bank manufacturing PMI was a little better at 49.3 vs. 48.4, but the services PMI roared back to life, up from 49.4 to 52.1. Japan was the only region where the manufacturing slump had spread to services, so this is good news. Is it due to the US-China trade deal? In which case, it’s only sentiment and could be vulnerable to the coronavirus developments.
Inflation: The Japan national CPI (consumer price index) year-on-year rose from 0.5% to 0.8% in December and the core CPI (ex-fresh food and energy) also edged up from 0.8% to 0.9%, the highest since 2016, still a long way from the Bank of Japan’s 2% target.
Oil prices slumped as the coronavirus crisis spread in China, with concerns about global growth.