The worst one day sell-off in US equities since 2011. Better than expected data on US wages triggered concerns about inflation and put pressure on the equity and bond markets. On Monday 5 February the S&P 500 slumped 4.1%, with volatility-related strategies sharply deleveraging. The VIX suffered its largest daily move (from 17 to 37) on Monday, to reach its highest level since August 2015. The two most popular short VIX Exchange Traded Products, which had seen massive growth in assets under management over the past few years fell by 96% and halted trading. The market was largely driven by technical flows in the absence of fundamental buyers. We remain comfortable with fundamentals, which remain largely supportive, and believe the market sell-off represents neither a significant tightening of financial conditions nor an economic slowdown.
Earnings in the US and euro area continue to positively surprise. Fourth quarter earnings season is in full swing in the US and euro area. So far, the reported numbers are encouraging and indicate robust earnings growth, beating consensus estimates in both regions. Sales growth and earnings growth in both regions are currently comparable (close to 8% and 15% year-on-year respectively) and are beating consensus estimates. Financials, technology and commodities are the key sectors driving positive results.
SPD members now have the floor. The final German grand coalition deal was reached on Tuesday. As in the pre-agreement, there is a strong emphasis on Europe. Domestic policy priorities are mostly in line with the CDU/CSU manifesto, however key ministries (finance, foreign and labour) will be handled by SPD. Now, the SPD members have to validate the deal through a referendum that will most likely be held on 4 March. The outcome of the referendum remains very uncertain amid a leadership change with Andrea Nahles in line to replace Martin Schulz as head of the party.
In the UK last week, the Bank of England left monetary policy unchanged, but its Inflation Report press conference was more hawkish than we and markets expected. The Bank warned that policy might need to be tightened “somewhat sooner and to a somewhat greater degree” than had been envisioned in November. While we have clearly held a more hawkish outlook than the BoE since November, we did not expect this emphasis at this meeting. It raised the perceived likelihood of a May hike (markets see this as around two-thirds likely), with the prospect of a follow-up in November. For now, we retain our outlook for an August hike. We expect tighter financial conditions, Brexit uncertainty and a willingness to monitor wage deals to temper the BoE’s enthusiasm, yet we recognise the risk of an earlier move. This week’s CPI inflation and retail sales are unlikely to alter the outlook greatly. We join consensus in looking for a modest dip in CPI inflation to 2.9%, while we question the scale of rebound penciled in for retail sales in January.
The US saw another government shutdown. The US suffered its second government shutdown this year, albeit one that lasted only a few hours before a more permanent agreement passed through Congress. Broad spending limits were increased for defence and non-defence spending, which will push deficits higher by around $300bn over the coming two years. Detailed spending plans will need to be agreed by 23 March. The debt ceiling was also suspended until March 2019. The coming week will sees less attention on Washington – although an immigration debate will be watched. Economic data will return to focus with key retail sales and CPI inflation data for January released – the latter of specific focus for bond markets. And we will watch for any persistent aftershocks in US markets.
Euro area: EMU December industrial production (Wednesday), Spain and Germany 2017 fourth quarter GDP growth (Wednesday)
US: 2019 budget blueprint (Monday), CPI and retail sales (Wednesday), housing starts (Friday)
Market and asset types measured by the following indices: Equities = MSCI. Fixed Income = JP Morgan and BofAML.
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