Macro insights

US Fed speech helps drive market rebound while Eurozone business surveys remain fragile

Comments from Powell partly correct the Fed’s failure to deliver a “dovish hike”. US Federal Chair Jerome Powell discussed “patience” over monetary policy tightening, and suggested the Fed would always be ready to adjust its balance sheet policy, if it thought it was tightening conditions too quickly – a marked change from December’s “auto-pilot” run-off response. The rhetoric helped the S&P 500 post a 3.4% gain on Friday, lifting stocks 1.9% on the week and 7.7% from Christmas Eve’s low. Questions persist about the outlook for the economy, with a sharp drop (the biggest since Lehman’s) in the ISM index last week heralding a slowdown. However a strong December payroll report – the best since September 2016 – suggests there is solid expansion underway but financial conditions will ultimately determine 2019’s pace of growth. This week’s first formal trade talks between the US and China, since the announced 90-day truce at the Buenos Aires G20, could bolster hopes of a benign resolution. However, domestically the inability to re-open sections of the US government due to ongoing differences over funding President Donald Trump’s “wall” could increasingly impact sentiment. But so far the immediate direct economic impact appears small and we estimate, the situation will have knocked less than 0.1 percentage points off GDP growth in the fourth quarter (Q4) of 2018 and the first of 2019. For now, we continue to forecast US economic growth of 2.3% in 2019, versus a consensus of 2.6%.

Short-term focus for equity markets will shift to trade and growth. Earnings growth is expected to slowdown in the fourth quarter reporting season, reflected in the negative revisions since September, due to a mix of top line and margin pressures. Management guidance will be a key anchor for markets and should underpin the direction of 2019 earnings estimates, as witnessed with Apple’s recent negative sentiment. Positive surprises would help break the ongoing negative feedback loop between equity prices, confidence and investment. Consensus expectations are now close to our earnings growth target of 7% highlighted in our 2019 Outlook, while investor positioning appears to be extremely light and valuations are back to near 2015-2016 lows. Recent pricing and wages trends indicate that profit margin movements are likely to be mixed across sectors.

The latest Eurozone business surveys remain weak with December’s composite Purchasing Managers Index (PMI) falling to a four-year low, on a growing list of concerns including global trade, the economic outlook, rising political uncertainty, Brexit, tighter financial conditions and auto-sector weakness. At a country level, business surveys remained depressed. For example, the French INSEE dropped to a two-year low as the ‘yellow vests’ protests triggered a seven-point correction in retail trade confidence, while the December IFO disappointed on weaker expectations. Germany’s factory orders also fell short of expectations declining by 1% month-on-month (m/m), despite some rebound in the auto sector. Germany’s November industrial production figures, due Tuesday, will help to gauge the health of the German economy at the turn of the year. Overall we expect a Q4 GDP rebound to 0.3% quarter-on-quarter (q/q) after the Q3 contraction of 0.2% q/q.

The UK enters 2019 with the same problem. Parliament returns to session today, discussions begin on Brexit from Wednesday and it is confirmed that a vote on the Withdrawal Agreement will be held on Tuesday 15 January. Prime Minister Theresa May’s deal looks no more likely to pass this year, than it did last, despite her stating its rejection would leave the country in “uncharted territory”, risking a no-deal Brexit. Five leading UK business lobbies warned this would result in “severe dislocations and disruption”. But a recent YouGov poll suggested Tory members would prefer such an outcome (57% favoured no deal, 23% May’s deal and 15% wish to remain). Parliament seems to be manoeuvring to avoid such an outcome. Some 209 cross-party lawmakers signed a letter urging the PM to avoid such a course. Separately, amendments tabled to the Finance Bill would prevent the use of funds for no-deal measures without Parliamentary authority. Brexit continues to affect the economy - a rebound in December’s manufacturing PMI last week, to a six-month high, was attributed to precautionary stock-building. Elsewhere house prices posted their biggest monthly price fall in seven years as mortgage approvals dropped. Monthly GDP data this week will guide expectations for Q4, which we expect to rise by 0.3% to deliver 2018 growth of 1.3%. The outlook for 2019 will depend on the path Brexit takes but we have pencilled in 1.6% for now, against a consensus 1.5%.

China steps up policy easing to counter growth headwinds. The People’s Bank of China (PBoC) announced last week a broad-based RRR cut, worth 100 basis points, to prepare the market against upcoming liquidity squeezes ahead of the Chinese New Year and maturing MLF loans in Q1. However, with a net liquidity injection of RMB 800bn, we think the PBoC has a clear intention to bring more monetary support to the economy, which is confronting a number of growing headwinds. Weak PMIs and industrial profits, coupled with anecdotes of softening labour market conditions, suggest the economy is losing steam at an accelerated pace. Hence, we expect more policy responses to arrest downside risks, with fiscal policy doing the heavy-lifting (e.g. VAT and fee reductions for corporates, along with infrastructure investment) supplemented by monetary supports. For the latter, we expect three to four RRR cuts in 2019, with part of the liquidity injections used for replacing matured MLF loans.

Upcoming events

Euro Area: EU19 Business and Consumer Confidence and German Industrial Production (Tuesday), EU19 and Italian Unemployment, German Trade balance and Current account and French Insee consumer confidence (Wednesday), French Industrial Production (Thursday), Italian and Spanish Industrial Production (Friday)

US: Trade Balance and JOLTS job opening (Tuesday), FOMC December meeting minutes (Wednesday), Weekly jobless claims (Thursday), CPI (Friday)

UK: Halifax house prices (Tuesday), UK Parliament begins new debate on Brexit deal (Wednesday), BRC retail Sales Monitor (Thursday), GDP, Manufacturing and Construction output, Industrial production and Total trade balance (Friday)

China: CPI and PPI (Thursday)

Japan: Consumer Confidence (Tuesday), Trade balance and Current Account balance (Wednesday), Leading index (Thursday), Economy Watchers survey (Friday)


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