Global macro economic update on the week ahead (Week beginning 26 February)

Michael Ford

Summary

• Next week, attention will focus on the new Federal Reserve Chair Jerome Powell’s first semi-annual monetary policy testimony to Congress.

Strategy review

Spike in volatility provides attractive opportunity

Markets are re-calibrating to both an adjustment to a higher volatility environment and to a higher risk premium in the rates curve. This is occurring against a backdrop of strong economic growth and, while inflation should move higher, it is still below central banks’ targets. While volatility shocks are by their nature difficult to predict, they do typically lift risk premia to attractive levels in the near term as markets become significantly more risk averse.

Market and economic review

Federal Open Market Committee: statement says “further gradual policy firming would be appropriate”

On Wednesday, minutes from the Federal Open Market Committee (FOMC) January meeting said “a majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate”. This statement was initially taken as an indication that the Fed might raise rates quicker than previously estimated, causing US 10-year yields to rise to 2.95%. Since then, yields have fallen back to levels seen at the end of last week. We note the Fed’s Kashkari said “I think ‘further’ is intended to say continuing the current path that we’re on” and “Wall Street overreacts to everything”.

Equity markets: range trade after last week’s gains

After equities troughed on 8 February, there has been a strong rebound. Last week, the S&P 500 Index posted the strongest gain in over five years. This week equities have been very choppy but have range traded. While there has undoubtedly been a lifting of both volatility and yields, the overall outlook appears supportive of risk assets in the medium term. The US dollar strengthened over the week, but this is only a partial reversal of the long-term downtrend.

Data: US provisional PMIs above expectations, European provisional PMIs disappoint but remain supportive

This week we had the provisional PMIs for the key economies. The US manufacturing PMI at 55.9 was above expectations, while the eurozone PMI composite at 57.5 was below expectations. The fact that PMIs remain at solid levels is supportive of our view that risk assets should perform well over the medium term as the recent upswing continues, but at a slower pace.

Brexit: UK wants longer transition and “Canada plus plus plus” as Labour says it wants to stay in a customs union

On Wednesday a leaked document revealed the British government wants the transition period to last longer than the EU’s 21-month limit. On Thursday a UK cabinet meeting decided on the government’s plan on the future relationship with Europe which has been branded “Canada plus plus plus”. More details are expected in Theresa May’s speech on 2 March. Previous statements from the EU indicated they would reject any attempt to “pick and choose” aspects of the single market. Attempts for a hard Brexit could suffer a setback as Jeremy Corbyn has said the UK will “have to have a customs union” with the EU after leaving the bloc.

Outlook

Central bankers in focus next week

On Wednesday and Thursday next week the new Fed Chairman Jerome Powell will deliver his semi-annual monetary policy testimony to Congress. Given the reaction to the new wording of the FOMC meeting minutes and the recent focus on inflation and interest rate increases, the testimony could give indications as to the Fed’s thinking. Separately, European Central Bank president Draghi will address the EU parliament on Monday.

Several data releases next week

Next week there will be data on US real GDP, core PCE, housing data and durable goods orders. The euro area will have inflation, GDP and PMI releases. There will also be manufacturing PMI data from China and Japanese industrial production figures will be released. Back in the US, the closely watched ISM report will be released on 1 March, but we will have to wait for the following week for the all-important US labour report.

Politics: May’s Brexit speech on 2 March and Italian election on 5 March

Next week Theresa May will give a speech outlining the UK government’s plans for the long-term relationship with the EU. There is likely to be news flow on the EU reaction to her proposals. In just over a weeks’ time there will be the Italian election, for which we are currently in a blackout period.

By Michael Ford, portfolio manager in the Multi-Asset Group