Macro insights

US posts solid economic data, Brexit moves to stalemate while President Macron moves to calm protests

US economic data continues to point to solid activity. Core’ inflation (CPI and PPI) rose, the labour market tightened (initial claims and JOLTS) while November’s activity data - retail sales, industrial output and inventories - came in ahead of expectations. But despite this, the equity market posted further declines, with the S&P 500 down 1.3% on the week and 11% from its September high. This Wednesday the US Federal Reserve announces its latest decision on monetary policy. We expect it to raise the Fed Funds Rate by another 0.25%, increase the interest on excess reserves (IOER) by a smaller 0.2% – and to remove the reference of “further gradual increases” from its accompanying statement. The Fed will also publish its quarterly macroeconomic forecast, and we expect the outlook for headline inflation to be lower (in the wake of a stronger dollar and lower oil prices). We also anticipate that the Fed will lower its forecasts of future rates (dots). The Fed currently suggests three hikes in 2019 and one in 2020. This could be reduced to two in 2019 and one in 2020. Fed Chair Jerome Powell is also likely to convey a dovish tone in the press conference, stressing that the Fed is close to neutral, and will be increasingly ‘data dependent’. Yet with markets geared for a dovish meeting, even this combination may not prove sufficient to bolster sentiment.

The Central Economic Work Conference takes place this week (18 - 20 December), where the national agenda will be set for 2019. Overall, we expect no surprises from this meeting as Beijing has already clearly indicated the need to step up macro policy support, via fiscal policy and tax cuts to deliver stability in 2019. In addition, its growth target will also likely be lowered on the back of the expected slowdown. November’s activity data, released last Friday, again suggested the slowdown has continued, with industrial production down from 5.9% year-on-year (yoy) to 5.4%yoy while retail sales edged 0.5 percentage points lower to 8.1%yoy –- both missing market expectations due to the sharp contraction in the auto sector. On the other hand, year-to-date fixed asset investment growth increased from 5.7%yoy to 5.9%yoy, supported by manufacturing investment. Infrastructure investment remained steady, suggesting that official attempts to revive investment in the sector via more local government bond issuance and relaxation on PPP projects have filtered through and are reasonable sustainable. We believe infrastructure investment will serve as a key growth driver going forward as the government continues to push for infrastructure investment-driven policy stimulus. With data increasingly starting to signal a slowdown, we maintain our 2019 growth forecast at 6.1%yoy.

Frenetic week for UK politics but absolutely no progress on Brexit. The week started with PM Theresa May pulling the vote on her negotiated European Union (EU) withdrawal agreement in expectation of a heavy loss in Parliament. She subsequently faced, and survived, a leadership challenge (at 200 votes to 117) before heading to Brussels to seek further assurances – which were not particularly forthcoming, but where discussions will continue into 2019. The outlook for Brexit remains as uncertain as ever. Her compromise is deeply unpopular with Parliamentarians, who have even less stomach for a “no deal” Brexit, but the Prime Minister continues to rule out a second referendum. This stalemate looks set to break only in the New Year, as May promised the postponed vote will take place by 21 January. This week the Bank of England makes its last monetary policy decision of the year. We expect policy will be left unchanged but accelerating wage growth will likely disquiet Monetary Policy Committee (MPC) members. Brexit aside, the MPC would likely have increased Bank Rate in February. However, with Brexit uncertainty likely to continue to overhang the 7 February Inflation Report meeting, we forecast that the next hike could occur on 2 May, although there is an outside chance of this happening on 21 March.

European Central Bank (ECB) confirms the end of QE on December 18, revises down its growth and inflation forecasts, albeit slightly, and reiterates its forward guidance on rates i.e. no movement until at least the summer of 2019. The ECB enhanced its forward guidance on reinvestment by making it, not only state, but also date contingent (“for an extended period of time past the date when it starts raising the key ECB interest rates”). Technical details revealed, as we expected, that reinvestments will operate under the market neutrality principle via smooth and flexible implementation, in particular helped by the reinvestment horizon (distributed over a year instead of three months previously). Regarding TLTROs, ECB President Mario Draghi said that they were mentioned but not discussed. Our present 2019 GDP growth scenario, is much more cautious than the ECB at 1.4% vs. 1.7%. In addition, we believe banks will face a number of challenges in 2019. These include having to repay TLTRO II loans while TLTRO II will drop below a residual maturity of one year at the end of June, thus becoming ineligible for Net Stable Funding under Basel III. As such, we believe T-LTRO funding will be rolled out in some form, in the first half of 2019, with an announcement potentially taking place on 19 March.

Last Monday President Emmanuel Macron announced a series of fiscal measures to abate the “yellow vest” protests. These include the extension of tax credits, which will provide a monthly boost of €100 for those on minimum wage, the de-taxation of overtime and the cancellation of the 1.7% tax hike for pensioners living on below €2,000 a month. We estimate these measures will cost approximately €11bn (including circa €4.5bn from the cancellation of the fuel tax and various incentive schemes for the replacement of older cars and home boilers) and push the fiscal deficit to 3.4% in 2019 – up from 2.8% in the budget and 2.6% in 2018. Together with the Eurozone-wide economic slowdown, French public debt would no longer decrease but be on a slightly upward trend. Yet, the 2020 deficit should be back below the 3% threshold, as the 2019 deficit is also boosted by a significant one-off trigger – the transformation of tax credit CICE into a permanent payroll tax cut worth some 0.9% of GDP. We believe this will be one of the arguments emphasized by the French government in its discussion with the EU. Beyond triggering a political answer, social unrest also pushed confidence massively lower in December. Euro area flash PMIs released last week fell significantly, by 1.4 point to 51.3 in December, marking the lowest reading since November 2014. The drop was driven by France, and in particular by the sharp fall in services PMIs to 49.6 (-5.5 points) on the back of street protests, a 34-month low.


Upcoming events
Euro Area: German IFO business climate index (Tuesday), German PPI (Wednesday), EU19 flash Consumer Confidence, French Q3 GDP, Consumer spending & Insee Manufacturing confidence and Italian ISTAT confidence (Friday)
US: Building Permits & House starts (Tuesday), Current account balance, Existing home sales & FOMC announcement (Wednesday), Philadelphia index, weekly jobless claims and Leading index (Thursday), Q3 GDP, durable goods, PCE price index, Personal Income, Michigan consumer sentiment and deadline to avoid US Government shutdown (Friday)
UK: CPI, RPI, PPI and CBI Distributive Trades Survey (Wednesday), Retail Sales, MPC announcement, House of Commons Recess (Thursday), GfK consumer confidence Q3 GDP, Business investment, Current account PSNB (Friday)
China: Central Economic Work Conference Day (Wednesday)
Japan: Trade Balance (Tuesday), ‘Core’ CPI (Thursday)


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