Global macro economic commentary on the week ahead from Insight Investment
Steve Waddington
Summary
Next week attention will remain on the possibility of trade frictions while Italian elections, the Chinese National People’s Congress and US labour market data will also be closely watched.
Strategy review
Volatility remains elevated as trade fears add to an adjustment in risk appetite
The adjustment to a higher-volatility environment and to a higher risk premium in rates continues to present a challenging environment for markets. This week saw new information in the form of the first public testimony of the new Federal Reserve (Fed) Chair Jerome Powell to the US House and Senate, as well as a batch of inflation and growth data. The latter was in the form of the purchasing manager’s indices (PMI), which were released around the turn of the month. Against this backdrop, markets were choppy. News towards the end of the week regarding President Trump’s plans on tariffs on steel and aluminium imports caused another bout of risk aversion. Equity markets ended up the primary casualty while government bond yields fell from their recent highs.
Market and economic review
Trump tariff plans rattle markets and overshadow new Fed chairman
On Thursday, President Trump announced the imposition of tariffs on imported aluminium (10%) and steel (25%), and will sign a formal order in the next week. This unnerved markets at a time when sentiment was already fragile. Initial responses by the European Union (EU), China and Canada hinted at retaliatory measures, although it appears that they will await details of US plans before responding more formally.
This news overshadowed new Fed Chair Powell’s testimony in which he painted an upbeat view on the economy, but suggested rate hikes should be gradual. The market pricing for rate hikes this year moved higher, with three hikes now being largely discounted by the market, while the possibility of four moved above 70%. Longer-dated yields, however, were pretty well behaved with the 10-year treasury ending the week at 2.80% after President Trump’s announcement of metal tariffs, well below the recent high of 2.95%.
Contrasting growth data, while inflation data does not add to market fears
On the macro data front, the closely watched US ISM was stronger than expected (60.8 versus estimates of 58.7), marking the highest level since May 2004. There was contradictory information from China with a notable miss in the official Chinese PMI, which triggered a bout of local equity market weakness until a private sector (market) release pointed to a mild improvement.
European PMIs recorded a small upgrade to the provisional releases and suggested strong European growth albeit off the peak. In mainland Europe inflation data helped soothe bond market fears. The euro area’s February headline and core consumer price index (CPI) were both in line at 1.2% and 1% (year-on-year) respectively, while Germany’s CPI was 0.1ppt lower than expectations, at 0.5% month-on-month and 1.2% year-on-year respectively, with the annual rate at a 16-month low. France and Italy’s CPI prints came in below expectations while Spain’s numbers surprised on the upside. The most important US inflation news came on Thursday in the form of January’s PCE data, but in-line readings (0.3% month-on-month and 1.5% year-on-year) were not a source of market concern.
Brexit uncertainty continues
On the Brexit front, UK Prime Minister Theresa May’s speech outlining the UK government’s plans for the long-term relationship with the EU did not meet a warm reception from the EU negotiators. The European Commission also released its own draft legal text on the Article 50 withdrawal agreement and this served as a reminder as to how far apart the parties are from any sort of agreement. Of particular focus is the status of Northern Ireland post-Brexit and this looks like being a significant sticking point on agreeing a way forward.
Outlook
Trade, politics and central banks
Given events of the last week, the follow-on from the Trump tariff announcement is going to be a key market driver as markets consider the prospect of retaliatory action and trade wars. The outcome of Sunday’s Italian election will be also a focal point. Expectations are for a hung parliament and possibly a technocrat-led government, but this is no longer viewed as an event with wider European ramifications.
At the start of the week, China’s two-week National People’s Congress also begins. Beyond the setting of economic targets it is expected that the term limits on the president and vice-president will be changed or removed.
On the central bank front, the Reserve Bank of Australia, European Central Bank (ECB) and the Bank of Japan are due to meet (announcements due on 6, 8 and 9 March respectively) but no change in policy is expected. The ECB meeting will probably be the most closely watched of the three because analysts are looking for signs as to whether the central bank might tweak its guidance on policy normalisation. Given current market sensitivities, policymakers may be concerned that the market could overreact to any perceived change in direction of policy.
In the US, a number of Federal Open Market Committee members will make speeches at various conferences. With the markets’ focus so concentrated on whether or not the Committee is moving towards four 25bp rate hikes at this month’s meeting, rather than the currently discounted three, their comments should give a steer on how the majority is moving on this front.
On the macro data front, there will be a range of industrial production and durable goods order releases over the course of the week and these will be closely watched given that most PMIs are suggesting strong but possibly moderating growth (the US ISM not withstanding). The key data highlight comes on Friday with the release of the February US labour market report.
By Steve Waddington, Portfolio Manager in the Multi-Asset Strategy Group
