US threatens China with new tariffs while the Eurozone surprises on the upside

President Donald Trump’s Sunday night tweets, announcing that the US would raise tariffs on China to 25% this Friday, blind-sided Asian markets.

As a result, Chinese equities dropped sharply during Monday’s session, although they rebounded modestly on Tuesday. However, the impact dissipated across Monday’s trading day and US markets closed just 0.5% lower. On Thursday China’s Vice Premier Liu He, will visit Washington for further talks. We continue to expect that the US will move towards a deal over the coming weeks - and that it will not impose the tariff increases this week. President Trump’s continued bellicose rhetoric underlines the downside risk we see to the global outlook with regards China, and more broadly with the European Union and United States – Mexico - Canada Agreement (USMCA).

Elsewhere, markets continue to question the Federal Reserve’s outlook, following Fed Chair Jerome Powell’s latest comments, where he described the current inflationary softness as “transitory” – a sentiment, echoed by subsequent Fed speakers. This suggests that without further inflation softness, the Fed is unlikely to use inflation as a reason to lower the policy rate this year and we continue to anticipate that the Bank will stay on hold throughout the rest of 2019. Fed Chair Powell speaks again in Washington on Wednesday and Friday’s CPI inflation print for April will be closely watched. But we continue to see a deterioration in the outlook with the renewed trade concerns, the most likely reason for policy easing this year.

Euro area: Eurozone GDP surprised on the upside, growing by 0.4% quarter-on-quarter (qoq) during the first three months of 2019.

The positive numbers were broad based in terms of country, with Italy posting 0.2% growth, and therefore exiting its technical recession. Spanish economic activity accelerated to 0.7% qoq while France achieved growth of 0.3%, the same as in the last two quarters. German GDP will be released on 15 May, and we expect it to rise by 0.3% qoq, a slight improvement compared to the 0.2% recorded in the fourth quarter of 2018. But business surveys remain depressed in the manufacturing sector, especially in Germany; March factory orders disappointed, rebounding only by 0.6% month-on-month after two months of sharp declines. Excluding large and volatile orders, factory orders shrank by 1.9% month-on month, with only tentative signs of improvement on the external sector. This is in line with our view that Chinese spill-overs will be felt only with a few months lag.

Following the Bank Holiday and last week’s regional elections, Cross-party Brexit talks resume today.

The results saw the Conservatives lose around 1,300 local seats, with the Liberal Democrats, the Greens and others gaining, while Labour and UKIP both lost around 100 seats each. While local elections rarely send definitive signals about national prospects, these clearly showed voter dissatisfaction over the current Brexit impasse – even if the message about the way forward was more ambiguous. Yet with heavy losses threatening both the Conservatives and Labour at the upcoming EU elections on 23 May, the incentive for co-operation has increased.

is still unlikely to deliver a deal but we expect another attempt to pass the Brexit agreement over the coming weeks. Separately, Friday sees the publication of UK output data for March, including Q1 GDP growth. Markets expect a solid 0.5% gain, although in part due to precautionary pre-Brexit stock building, which is expected to unwind. The Bank of England’s Inflation Report last week clearly stated that the Monetary Policy Committee considers rate hikes above the current market pricing for one, over three years. We consider rates likely to rise by three times over the coming three years. However, with the Bank expecting ongoing spare capacity in the UK in 2019, growth to fall back to around 0.2% per quarter and Brexit uncertainty likely to remain elevated, we suspect that the it will only begin its medium-term adjustment process next year.

Upcoming events
Euro Area: German Industrial Production (Wednesday), Spanish Industrial Production (Thursday), German Current Account and Trade Balance, French and Italian Industrial Production (Friday)

US: PPI, Trade balance, Jobless Claims and FED’s Powell speaks in Washington (Thursday), CPI (Friday)

UK: BRC Retail Sales Monitor, Halifax House prices (Wednesday), RICS Housing Survey (Thursday), GDP, Industrial Production, Manufacturing and Construction Output, Index of Services, Business Investment and Total trade balance (Friday)

China: Trade talks, Trade balance and, CNY exports/imports (Wednesday), CPI and PPI (Thursday)

Japan: Consumer Confidence (Thursday)

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