US Fed and EU summit in focus
The US Federal Reserve meeting on Wednesday will be the market focus in an otherwise relatively quiet week. There is little doubt about the Fed’s immediate policy outlook, with every Federal Open Market Committee participant recently referencing a “patient” approach. The Fed will almost certainly leave policy on hold at this week’s meeting, refer to a solid domestic outlook, but continue to reference “cross currents”, capturing risks from overseas and financial conditions.
As a result, markets, will instead, watch the “dots” – Fed participants’ rate forecasts for the coming years. Vice Chair John Williams and Governor Lael Brainard recently demurred from providing guidance for end-year policy – a luxury that the publication of the dots will not afford. We expect Fed participants’ interest rate projections to be lowered across the board from December, likely including some lowering of the estimated neutral rate.
We expect a median of one hike to remain for this year, despite market expectations that a cut is now more likely than a hike – something that could unsettle markets in the short term. We will also look for further clues about the Fed’s planned balance sheet unwind. We now expect quantitative tightening to be curtailed over the second half of 2019, with the balance sheet unwind being frozen at the end of the year. In terms of economic data, Thursday’s Philadelphia Fed survey for March will be closely watched, as will Friday’s existing home sales figures, following the sharp retracement in new home sales last week. Congress will be out of session this week. However, we will continue to watch for developments in trade negotiations.
China not out of the woods yet: The combined January and February data confirmed a difficult start to the year for the Chinese economy. Weak external demand is partly to blame, as the Sino-US trade war exacerbated the decline in exports that has been driven by worsening global growth. At the same time, the domestic economy isn’t firing on all cylinders, with retail sales growth and most of the investment components still decelerating from the fourth quarter of 2018. What is more worrying is that the labour and housing markets are showing signs of cracks, which would worsen the economic outlook if left unchecked.
The good news is that policy responses have been ramped up, and their effects are gradually working through the system. However, given how heavily the poor economic numbers weigh, it will likely to take more from Beijing to keep the country’s economic aeroplane at the targeted (6-6.5%) altitude. We expect the government to accelerate the implementation of the measures announced at the National People’s Congress, helping the economy to find a bottom around the middle of this year.
Euro area tentative signs of stabilisation: Last week was relatively quiet in terms of politics and data in the euro area, with just January industrial production (IP), the first hard indicator for the first quarter, released. Euro area IP surprised to the upside, bouncing back by 1.4% month on month (mom), pushing the first quarter 2019 IP carry-over to 0.4% quarter on quarter (qoq). This would represent an improvement from the negative quarterly growth recorded in the last two quarter of 2018 and would be consistent with our euro area GDP growth forecast of 0.24% qoq for the first quarter. One country was nonetheless an outlier: German IP fell by 1.1%mom on weak car production, but the latest figures might have been distorted by strikes at a major car maker’s factories.
Next week, attention will focus on Flash PMI figures for March, which will likely continue to show divergence between the services sector, which is likely to continue to hold firm and weakness in the manufacturing industry. Indeed we do not see any catalyst in the short term for a significant improvement in manufacturing sentiment- we rather expect it to stabilise- as Brexit and trade war uncertainties persist and with Chinese data only likely to bottom out in the second quarter of the year in our view.
UK Prime Minister Theresa May is hoping the third time is a charm if she tries to pass the negotiated Withdrawal Agreement through Parliament again this week, after two heavy defeats. The government has been in talks with the Democratic Unionist Party (DUP) and Chancellor of the Exchequer Philip Hammond referred to a “significant” number of Tory rebels now supporting her deal as last week’s Parliamentary actions have shifted the alternative increasingly towards a delay, a softer Brexit and the possibility of a second referendum. However, the 149 deficit at last week’s vote is a large number to overturn and we would still expect a third defeat for the government, albeit a much narrower one, if the vote goes ahead as suggested before Wednesday.
Attention will focus on the EU Summit on Thursday, following the UK government’s request for an extension to Article 50. Despite, several potentially fatal complications, we expect a three-month delay to the Brexit process, something that we expect to bring further relief to sterling markets. The Bank of England also meets this week. However, stuck in Brexit limbo, the Bank will likely keep policy on hold and be unable to provide much clarity on policy outlook through the uncertainty that overhangs the economy. We continue to believe that if the UK achieves an orderly, transitional Brexit by mid-year, the BoE will tentatively begin to lift Bank Rate by year-end.
Euro Area: German ZEW survey (Tuesday), German PPI (Wednesday), ECB Economic Bulletin and EU19 Consumer Confidence (Thursday), EU19, German and French flash PMI and Junker/Tusk press conference (Friday)
US: Factory orders (Tuesday), FOMC announcement (Wednesday), Philadelphia Fed index (Thursday), Flash PMI, Existing home sales and Wholesale inventories (Friday)
UK: Unemployment and average earnings (Tuesday), CPI, RPI, PPI and CBI industrial trends survey (Wednesday), Retail sales, PSNB and MPC announcement (Thursday)
Japan: National ‘core’ CPI (Thursday), Manufacturing flash PMI (Friday)
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