Positive earnings, a patient Fed, a soft start for Europe

Positive earnings, a patient Fed, a soft start for Europe

Euro area: a weak end to 2018, a soft start to 2019. As expected the euro area ended 2018 on a weak note, growing by 0.2% quarter on quarter (qoq), a similar pace to that seen in the third quarter of 2018 but a deceleration from the 0.4% qoq growth recorded in the first half of 2018. This is consistent with an annual growth rate of 1.8% in 2018, down from 2.5% in 2017. Eurostat will provide GDP expenditure details on 7 March, but we estimate domestic demand should contribute to growth, although less so than in the third quarter of the year (+0.3pp in Q4 after +0.4pp in Q3 2018), while net trade was no longer a drag.

France and Spain surprised to the upside, growing by 0.3% qoq and 0.7% qoq, respectively, but Italy came in weaker than expected and has entered recession with GDP shrinking by 0.2% qoq. We believe that, as in the third quarter of 2018, investment was responsible for the brunt of the downward adjustment. Deteriorating business surveys, weakening credit demand and  tighter credit standards for investments as shown in the fourth quarter European Central Bank (ECB) Bank Lending survey point to limited appetite for Italian investment in a context of still elevated political uncertainty. We have revised our Italian GDP forecast to 0.2% yoy in 2019  down  from 0.4% yoy, as we do not expect a swift recovery in investment, see limited fiscal stimulus effects and believe global environmental uncertainty will likely continue exacerbate the domestic one.

US data rebound amid more patient US Federal Reserve. Last week saw the first Fed meeting of the year. The Fed’s statement removed reference to “further gradual increases” in the policy rate, instead explaining it could be “patient” in delivering future “adjustments”. Fed Chair Jerome Powell stated that he had “no prior” expectation for future moves (contrary to December’s Summary of Economic Projections) and that “cross-currents” could prove persistent. Yet economic releases provided an upside surprise. Payrolls rose by 304,000 (although December’s was revised lower by 90,000), unemployment rose to 4% (a temporary shutdown effect), and earnings were revised higher (3.2% in January from 3.3% in the fourth quarter of 2018).

We continue to see sufficient US expansion to warrant further gradual tightening and maintain our outlook for Fed hikes in June and December this year. However, this will rely on a continued easing in financial conditions and the improvement in the global growth outlook that we expect. Otherwise, the Fed seems ready to accept a more protracted pause. This week also sees President Donald Trump’s delayed State of the Union address. Trade policy and funding for a ‘Wall’ along the Mexican border look likely to be key topics.

S&P 500 still posting double digit earnings growth with 73% of reported companies positively surprising. Overall, 47% of the companies in the S&P 500 have now reported fourth quarter results, closer to 60% in market capitalisation terms. Aggregate top line growth currently stands at 6.2%, largely in line with forecasts. Earnings beat estimates by 2.8%, with growth currently at 14.7%. This compares to a 4.9% earnings surprise with 70% of companies posting earnings beats on average of over the past three years. Investors appear to be more focused on the reported numbers judging by the  stock price reactions observed during this reporting season. Initial results from the energy sector have been stellar, with growth coming in at 84%, positively surprising by 22%. Technology names are displaying slowing growth momentum with aggregate growth so far at 4.3%.

Disappointing Korean export figures indicate sluggish trade momentum to continue. Korean exports dropped 5.8% yoy in January, down from December’s 1.3%. This is the largest drop since mid-2016. While this can be partially blamed on unfavorable base effects, exports have turned soft as a result of the decline in export prices of semiconductors, oil products as well as a China slowdown (exports to China slowed for the third consecutive month in January). With Korean exports being a good leading indicator for the rest of EM Asia, we believe the coming January trade numbers for rest of the region should paint a softer picture. In addition, both headline and new orders PMI readings for most parts of the region dropped below the water-line. With China, Korea and Taiwan continuing to contract, we expect the slowdown in trade growth to persist on the back of weakening price pressures. Even worse, as the recent China-US trade meeting ended with little substantial progress, further trade war escalation has not yet been completely ruled out. On top of the possible tariff hike in March, a synchronised global slowdown suggests that the worst is yet to come before a turn around.

India’s interim budget suggests a softening stance towards fiscal consolidation. India’s government has pegged the fiscal deficit for the next fiscal year at  3.4% of GDP for both fiscal year 2019 and fiscal Year 2020, up from the original target of 3.3% and 3%. Policy makers have decided to lift fiscal expenditure prior the April/May election to provide some relief to agrarian distress. These include further spending (cash transfers and pension program) and tax exemptions for low to mid-income earners. Though this sort of populist move is largely expected by the public ahead of an election in an effort to gain popularity with voters, this is not a long-term solution to the core of the problem. While these targets suggest a slight pause in terms of fiscal consolidation, they are likely to be revisited by the “new government” in July. Apart from these fiscal developments, the Reserve Bank of India (RBI) is expected to turn more dovish on the back of softening inflation numbers. We expect  RBI to remain on hold in their February policy review.

Tuesday evening saw the UK Parliament vote to send Prime Minister Theresa May back to Brussels to try to renegotiate the Irish border ‘backstop’ agreement, but also separately saw it rule that it was against a “no deal” Brexit. There has been no progress since with the next votes scheduled to held next week on 14 February. The Bank of England’s next rate meeting and quarterly Inflation Report is scheduled for  Thursday. We expect no change in policy amid the significant Brexit uncertainty. Yet the BoE is likely to be increasingly fretful over the outlook for domestic inflation pressures – particularly rising wage growth amidst slowing productivity. We expect a hawkish press conference in preparation of an expected May hike, even as we recognise that a perpetuation of the Brexit uncertainty could still force the BoE to defer its next hike into the third quarter.   

Upcoming events:
Euro Area: EU19, German, French, Italian and Spanish PMI (Tuesday), German New manufacturing orders (Wednesday), ECB publishes economic bulletin, European Commission publishes Economic Forecast and German and Spanish Industrial Production (Thursday), German Trade Balance and Current account and French and Italian Industrial Production (Friday)
US: Services PMI and ISM non-manufacturing index (Tuesday), State of the Union address by President Trump, Non-farm productivity and Unit Labour costs (Wednesday), Weekly jobless Claims (Thursday)
UK: BRC Retail Sales monitor and Services PMI (Tuesday), Halifax house prices and MPC Inflation report (Thursday)
Japan: Leading index, Trade Balance, Current account balance and Housing loans (Thursday), Economy Watchers survey (Friday)
China: Foreign exchange reserves (Thursday)



Market and asset types measured by the following indices: Equities = MSCI. Fixed Income = JP Morgan and BofAML.  


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