Trade tensions and US corporate earnings are likely to remain front and centre
Trade tensions are likely to remain in the headlines next week as the European Commission President Jean-Claude Juncker meets President Trump in Washington on Wednesday to discuss potential US tariffs on European autos. The US earnings season also ramps up with around 40% of the S&P market cap reporting.
The European Central Bank (ECB) meeting takes place next week, although it is unlikely to change policy; markets will again be parsing Mr Draghi’s comments to get a steer on the direction of policy. Having said interest rates will not rise until summer 2019, and outlined a planned run-off for bond purchases last time round, we believe Mr Draghi is unlikely to reveal anything much in the way of news next week.
On the data front, preliminary purchasing managers’ indices (PMIs) for Japan, Germany, France, the eurozone and the US should be the major focus. Our analysis of the lagged impact of Chinese financial conditions suggests some further moderation in the balances is likely – although the US could buck this trend as the impact of fiscal easing continues to works through.
Away from the PMIs, US Q2 GDP, regional Fed survey balances, US durable goods orders, CBI surveys in the UK, the IFO survey in Germany and quarterly CPI numbers in Australia should be the main focus points. We’d be surprised if any of these numbers surprises in a way that will spook markets. If there is a surprise, we’d expect that to be weak outturns in the IFO survey, tying in with the recent/expected trend in the German PMI balance.
Weekly Summary
A week characterised by further uncertainty over US-China trade relations, NAFTA, Brexit and President Trump’s relationship with Russia
On a positive note, the US earnings season has started with a beat ratio of 93% and earnings-per-share (EPS) growth at 21%
Market and economic review
Markets: a weak renminbi the focus of attention
The Chinese authorities continued to let their currency depreciate this week – in response to the US approach to trade. Indeed, the Chinese renminbi (CNY) was around 1.3% weaker against the US dollar (USD) over the week. Although CNY has fallen more against the USD than it did in late 2015 (almost 8% since April), the steady decline and apparent justification for the fall this time round (to offset the impact of US tariffs) has, so far, prevented the large negative effects in risk markets that were seen back then.
The USD also made gains against a number of other currencies as nervousness associated with geopolitics and the continued relative strength of the US economy had the usual effects across currency markets. Sterling (GBP) had a particularly bad week against the USD as uncertainty over Brexit remained high (GBP/USD fell 1.6%).
With the USD stronger, the global outlook uncertain, and Chinese production data weaker than expected, commodities fell around 2% over the week, with industrial metals (copper in particular) and oil having a particularly bad run (supply issues also played a part in the fall in the price of oil).
The strong USD and widespread uncertainty meant emerging market equities had a bad week – falling around 1.5%. Within that, Chinese equity markets returned a loss of around 1%, though the CNY weakness appears to have underpinned more positive sentiment towards Chinese stocks at the end of the week. Most of the key developed equity markets managed to make small gains (of up to 0.5%), despite the nervousness over trade.
In the majority of the key bond markets, 2s10s slopes flattened a touch over the week – with the lower-than-expected UK inflation outturn resulting in a UK curve that was around 8bp flatter.
A strong start to the US earnings season: the beat ratio currently stands at 93%
The US earnings season kicked off in size this week with around 20% of firms having now reported. This included results from all of the major banks, where in contrast to last quarter, share price reaction to strong results was positive. The overall beat ratio is currently at 93%, a much stronger than average start, and the growth rate has ticked up to 21% (versus 20% expected). This headline growth rate can be broken down further with 8% from revenue, 3% from margins, 7% from tax changes, and 2% from buy-backs. Amid all the positive news, there has been the odd disappointment – Netflix subscriber numbers being around one million lower than expected, for example. But the overall tone of the season has been very encouraging thus far.
President Trump: trade, Russia and all that
It’s been another week of geopolitical gyrations as President Trump met President Putin in Finland, and initially refused to blame Russia for meddling in the 2016 US election – despite charges being laid against Russian nationals for trying to develop links between the Kremlin and the Republican Party and the apparent hacking/leaking of emails from Hillary Clinton’s election campaign. The refusal was widely condemned, given the implication it had for the work of US intelligence services. That prompted the president to suggest he had “misspoken” and really did believe the Russians had been involved.
While all this was going on, it was announced that trade talks between China and the US had stalled again. The US also suggested it might ditch the North American Free Trade Agreement (NAFTA) and try to strike separate trade deals with Canada and Mexico. Unsurprisingly, Mexico suggested this was not the best way to move forward.
It’s probably a little too early for the indirect impact of the US-China trade issue to be showing up in the data. Nonetheless, the trade numbers that were released for Singapore and Japan were worse than expected. In Singapore, exports rose only 1.1% in the year to June (versus a forecast of 7.6%), with electronic exports down 7.9%.
Brexit: further disagreement and political uncertainty
After the resignations of the last week or so, and the political uncertainty that generated, Prime Minister May had to accept amendments to her proposed Brexit plan. Brexiteers think these have fatally flawed the plan – particularly the requirement that the EU must agree to a reciprocal tariff collection scheme and that he UK must leave the EU’s VAT administration scheme (the prime minister did, at least, manage to hold off an amendment that would have required the UK to negotiate continued membership of the customs union if her plan is not accepted by the EU).
Business leaders continue to bemoan the apparent disarray in the Conservative party over Brexit and the impact this is having on getting a deal finalised. This week, the CEO of Rolls Royce announced the company was taking measures to prepare for a hard Brexit – having already decided to move engine design approval to Germany. The Governor of the Bank of England – Mark Carney – said there would be large economic consequences if no deal was agreed and that that would be material for interest rate policy.
FOMC: gradual increases okay for now
Away from the politics, Federal Reserve (Fed) Chair Jerome Powell presented his views on the economy and monetary policy to both the Senate and the House. His comments were little changed from those made after the Federal Open Market Committee decision to raise rates in June, except that the policy of gradual rate tightening was described as appropriate “for now”. These words are new. The US equity market thought these were dovish words, while the currency and bond markets thought they were a touch bearish. In our view, they are neutral. If trade issues have more of an impact than expected, rates won’t rise as much as planned. Conversely, if a tight labour market and the fiscal boost cause more inflationary pressure than expected, they will rise by more.
Data/events: weak Chinese and UK data
In a week where quite a lot of data was released, the standout numbers were probably the larger-than-expected fall in Chinese industrial production growth (down to 6% in June from 6.8% in May), and weaker-than-expected UK earnings growth, inflation and sales. Core UK earnings growth edged back to 2.7% in the three months to May (from 2.8%), while the core consumer price index (CPI) fell to 1.9% in June (from 2.1%). Away from the UK, much has been made of headline US retail sales numbers, but the fact of the matter is that control sales – which feed into the GDP number – were weaker-than-expected. US housing starts and permits were also disappointing.