Long-awaited US data, dovish central banks and Spanish politics

Following the 35-day government shutdown, that ended last month, the US begins publishing data on the economy again this week. December’s retail sales, and January’s CPI, PPI inflation and industrial production will all be released this week. Survey data is also released with the publication of February’s Empire State manufacturing survey and Michigan consumer sentiment. All will provide a more accurate assessment of underlying US economic conditions – which we still consider to be solid. However, as ever, political risk presents the biggest threat to financial conditions and are likely to prove the most significant headwind to future economic activity. A deadline for a funding bill looms again at the end of this week. However, given the political damage incurred during the recent shutdown, we do not see any party keen for a repeat.

A compromise bill was worked on in Congress last week, which would approve border “barriers” if no ”wall”. We expect this to pass ahead of this week’s deadline avoiding a repeat shutdown. Markets will also focus on the trade outlook. With under three weeks left until the 25% China tariff deadline (1 March), markets will look for an announcement of a summit between US President Donald Trump and Chinese President Xi Jinping to herald a breakthrough. On balance, we expect an increase in tariffs to be delayed beyond 1 March. 

UK GDP grew by 0.2% in the final quarter of 2018, weaker than consensus forecasts (0.3%), but in line with our own estimates. However, a weaker December for both manufacturing, services and construction output sees us soften our first quarter GDP growth outlook to just 0.25%. With Brexit uncertainty likely to persist for longer and downgrades to our 2019 Eurozone outlook, we have lowered our UK GDP forecasts to 1.3% and 1.5% (from 1.5% and 1.6%). The rest of the week will include CPI inflation estimates, which we expect to dip below the Bank of England target of 2% to 1.8% in January, largely the result of reduced energy prices (oil and regulatory). January’s retail sales figures are also due and we forecast a firmer rise than the consensus 0.3%. Yet Brexit politics will continue to dominate market reaction.

On Wednesday Prime Minister Theresa May will make a statement to the House. With no progress in renegotiating the Irish backstop agreement, weekend media reports suggested the Prime Minister will ask Parliament for more time. The following day’s Parliamentary debate on the process (including amendment votes), may well provide this additional time, possibly by setting out a formal timetable for an extension of Article 50. If Parliament fails to take such action, financial market confidence that the government will be able to avoid a “no deal” Brexit is likely to start to falter.  

Spanish politics in the spotlight. On Sunday, the conservative Popular Party, center-right Ciudadanos and far-right Vox parties managed to attract tens of thousands of supporters to a protest against the Spanish Prime Minister, Pedro Sánchez and, in particular, his handling of the Catalan independence drive. This followed last week’s government decision to accept the presence of an observer at the planned cross-party talks in Catalonia before breaking off negotiations on Friday.

It also comes ahead of a  busy week for Spanish politics, with the opening of the trial of the jailed Catalan secessionists on 12 February, and the start of the 2019 budget discussion. A first vote on the Budget is scheduled on 13 February, and the Socialist minority government would need the support of the Catalan separatist parties to pass it. Due to the highly fragmented political landscape and ongoing tensions with Catalan secessionists it is far from clear that the 2019 budget will be passed. While failure to do so would not necessarily trigger early elections, we acknowledge that recent demonstrations have increased pressure on Prime Minister Sanchez. We continue to see snap elections unlikely before the second part of the year and  general elections are due no later than 2020.

Upcoming Chinese data should help gauge growth pulse. Chinese consumers opened up their wallets during the lunar new year holiday last week, although spending failed to impress as the cooling economy took its toll. Retail sales on goods and catering services grew by 8.5% year on year (yoy), while tourism volume and spending rose by 7.6% and 8.2% respectively compared to the same period last year. While these are solid numbers in absolute terms, they are nevertheless the slowest growth rates since 2009, suggesting the headwinds facing the economy remain intense.

Over the next week or two, we expect to see further confirmation of China’s growth slowdown from the CPI and PPI, along with the January trade data, although the latter may be distorted by this year’s earlier Spring Festival. The People’s Bank of China’s credit stats also bear close scrutiny for signs of a bottoming of the credit cycle, which will be a key precondition for growth stabilisation in the real economy. Finally, China and the US will continue their trade talks in Beijing this week, making it a key event to watch for financial markets.

Dovish signals from emerging market (EM) central banks. In a context of ongoing disinflationary forces, central banks across emerging markets sent more dovish signals at their February monetary policy meetings. Policy rates were kept unchanged cross the board. Within EM Asia, the Philippines and Thailand held rates unchanged last week mostly on the back of softening inflationary pressure and increasing downside risks to growth. However, the Reserve Bank of India (RBI) made an earlier than expected move by cutting rates by 25 basis points and changed the stance from a calibrated tightening to neutral. Though the timing was a surprise, the actual move wasn’t as it was the result of the large reduction in RBI’s inflation forecasts and also because high real lending rates were starting to hurt growth.

There is a risk of another cut in April before the national election for India, however, especially as the real rates are still very high. Going forward, we expect most central banks, including the RBI to maintain a wait-and-see attitude with a dovish tilt possible towards the second half of 2019. In Latin America, The Central Bank of Brazil  left its policy rate unchanged at 6.5%, the lowest level in 30 years, backed by well-anchored inflation expectations in a context of ongoing sub-potential growth. Interest rates remained unchanged in Mexico and Peru as well. Eastern European central banks also stayed their respective hands, withPoland, Hungary, Czech Republic and Russia keeping rates steady. The National Bank of Romania decided to keep rates unchanged as well but given the large external imbalances, the Bank’s next moves will be significantly driven by the currency direction; were the depreciation pressures on the RON remain in place, the Bank may need to hike rates despite an expected decline in inflation driven by a drop in growth. Aside from the general benign inflationary backdrop, EM central banks’ dovishness was supported by a more “patient” US Federal Open Market Committee and therefore generally stronger EM currencies. EM assets were as well supported by expectations of a US/China trade truce, and hopes that effects of  ongoing Chinese policy stimulus would be apparent by the middle of the year.

 

Upcoming events:
Euro Area: EU Finance Ministers Meeting (Tuesday), Industrial Production (Dec) (Wednesday), GDP (Q4) (Thursday), Trade Balance and ECB’s Coeure speaks (Friday)
US: Powell Speaks and Job Openings (Tuesday), Building Permits, Core CPI and Crude Oil Inventories (Wednesday), PPI (Jan) (Thursday), Retail Sales (Friday)
UK: Carney speaks (Tuesday), CPI (Wednesday), Retail Sales (Friday)
Japan: Tertiary Industry Activity Index (Tuesday), GDP (Q4) (Wednesday)
China: New loans (Tuesday), Exports and Imports (Thursday), CPI and PPI (Friday)

 

Notes:

Market and asset types measured by the following indices: Equities = MSCI. Fixed Income = JP Morgan and BofAML.  

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