Macro insights

Italian and Argentinian political developments, while UK Q2 GDP is lower than expected

Italian politics is back in the spotlight.

Last week Lega leader Matteo Salvini submitted a no-confidence motion, following a contentious Senate vote on the construction of a high-speed rail link between France and Italy.  The Parliament, currently in recess, will have to vote on this motion by 20 August, which will likely lead to the termination of the Lega/Five Star Movement (5SM) coalition. After this vote, the President of the Republic of Italy will conduct a round of consultations with the aim of identifying a new possible coalition. A centre-left coalition between PD and 5SM is theoretically possible, and there have been some interesting developments over the weekend. In particular, divergences emerged within the PD party, as Matteo Renzi said that he would be open to a grand coalition while Party Secretary Nicola Zingaretti rejected it. Following developments within the PD party will be key to gauging the probability of snap elections. Assuming there is no grand-coalition, two other options are on the table. First a caretaker/technocrat government could be charged to pass the 2020 Budget law, but it would need to be approved by Parliament – and this is not a done deal. Second, President Sergio Mattarella could dissolve Parliament, with a general election taking place within 45-70 days. In this case, the timing would be quite challenging i.e. elections in mid-October, in the middle of the Budget discussion season - and it is not clear that the budget law could be approved by Parliament by year end. This would have non-negligible consequences, particularly VAT tax rates would automatically increase on 1 January 2020 with standard and reduced VAT rates rising by 3.2 percentage points (pps) and 3pp to 25.2% and 13% respectively as a part of a law previously passed to cap the growth of public deficit. In our view, a caretaker government would be slightly positive in the short-term, but general elections would be highly likely in early 2020, and with Lega’s current strength – with circa 38 % of voting intentions, close to seat majority with Brother of Italy - the return to orthodox fiscal policy is unlikely. This week in the Eurozone, beyond Italy, attention will focus on German second quarter (Q2) GDP growth, which we expect to be flat.

Argentinian primary elections’ unexpected results could spark financial instability, yet again.

Primary elections took place in Argentina last Sunday and revealed an unexpected wide advantage of opposition candidate Alberto Fernandes (leader of Frente Todos movement) over incumbent President Mauricio Macri (leading Juntos por el Cambio). This reflects the Buenos Aires province’s massive win of the Frente Todos candidate (with a 20-point margin to the incumbent), the Province concentrating more than a third of the electorate. The opposition candidate obtained 47% of votes support, which is more than the 45% threshold that would grant an outright win on a single round and scored 15 pps more than the next candidate, President Macri, which is more than the 10 point gap officially necessary to grant outright victory in case of casting 40% plus votes. The opposition’s potential of winning in October’s Presidential elections taking increased significantly, at odds with what the tight polls have been suggesting so far. As such, the uncertainty over policy has increased considerably and once again this puts Argentina into a situation of having to endure more financial instability, as the economic situation remains highly vulnerable.

The UK economy contracted for the first time since 2012 during Q2, with GDP falling by 0.2%, below the consensus forecast of stagnation.

Media commentary has focused on whether this will mark the start of a UK recession - defined as two consecutive quarters of shrinking GDP. At this stage, we do not expect such an outcome but the UK faces some daunting challenges. Global economic activity remains subdued, with broader European industrial production having contracted on an annual basis since November, and this will weigh on UK activity. Britain also faces headwinds from the current uncertainty surrounding Brexit – contributing to another 0.5% contraction in business investment in Q2, the fifth quarterly contraction out of six – and the threat of a serious economic shock in the face of a no-deal Brexit, as suggested by Prime Minister Boris Johnson. However, for now we do not expect the UK economy to contract in Q3. However, Q2’s contraction chiefly reflected a sharper unwind of inventory accumulation than we had allowed for – something that should not be repeated in Q3. Moreover, rescheduled maintenance outages in April saw a sharp drop in manufacturing output that we expect to be reversed in Q3. Both features should underpin expansion in Q3. That said, this week we will watch Tuesday’s labour market release for signs of weakness impacting the jobs market. CPI inflation and retail sales figures for July are also due this week. We expect retail sales to be modestly firmer than the consensus outlook for a -0.2% in July. 

The USD/RMB FX rate broke the 7.0 level, as the trade spat escalated, prompting the US to name China a “currency manipulator”.

The recent CNY/USD move to cross this barrier was in line with our expectation of the FX market reaction, given the recent trade-war escalation. The People’s Bank of China (PBoC) did not stand in the way of the market this time, as defending the yuan in a new environment of much higher tariffs could be costly and run counter to its intension to reform the exchange rate. In the near-term, the move has driven up market volatility and altered investor expectations. We expect the authorities to stay alert and stand ready to step in to prevent a repeat of the mini-crisis of 2015, using official communications, hiking funding costs for short-selling the CNH, tightening capital controls and selling FX reserves if needed. Over the longer run, allowing the RMB to cross the seven threshold shows Beijing’s commitment to FX reforms, which should allow the exchange rate to function as a more effective buffer for the economy, against (not least) the trade war. Elsewhere on the macro front, recent Chinese data – PMIs and trade – have beaten the already-depressed market consensus. However, with the manufacturing gauges still below 50 and exports barely growing, it is too early to call the cyclical bottom. Indeed, the upcoming tariffs on $300bn Chinese products, should they be implemented on schedule, are set to cause further malaise on Chinese exports to the US. We expect renewed weakness in the July data, due out this week, to nudge Beijing closer to adding policy stimulus.

US economic activity will remain a guide to global activity.

Last week’s softer PPI inflation data suggest downside risks to the outlook for CPI inflation on Tuesday, with markets looking for a rise in the headline rate to 1.7% (from 1.6%), and ‘core’ inflation set to remain at 2.1%. We will focus on August’s first business surveys with the Philadelphia Fed and Empire State manufacturing surveys published on Thursday. Both improved in July, with the Philadelphia Fed survey rising back to robust territory. We will watch to see if this is maintained into August, particularly as trade tensions have revived.  


Upcoming events

US: Consumer Price Index (Tuesday), retail sales, Philadelphia Federal Index, Empire State manufacturing survey, industrial production, preliminary Q2 Unit labour costs (Thursday), preliminary Michigan consumer sentiment (Friday)

Euro area: German Consumer Price Index (Tuesday), second estimate of Euro area Q2 GDP, Euro area industrial production, preliminary German Q2 GDP, French ILO unemployment (Wednesday)

UK: ILO Unemployment (Tuesday), Consumer Price Index, Retail Price Index, Producer Price Index (Wednesday), retail sales (Thursday)

China: Industrial production, retail sales, unemployment (Wednesday)

Japan: Industrial production (Thursday)

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