Central bank meetings, US employment report and global inflation data mark a busy week
It is a busy week for both data and central banks next week, with the BoJ, Federal Reserve (Fed) and Bank of England (BoE) all meeting. The BoJ meeting on Tuesday will warrant greater attention than has been the case for some time due to media reports on a potential tweak to yield curve targets, as discussed above.
The Fed meets on Wednesday and given that there will be no post-meeting conference and little anticipation of any policy change, this is likely to be relatively non-eventful. Finally, the BoE meets on Thursday, and a rate hike of 25bps is now 90% priced in.
The monthly US employment report on Friday is likely to be the data highlight this week, with consensus expectations for July payrolls and average hourly earnings expected at +185k and +0.3% month-on-month respectively.
The June PCE report on Tuesday and July ISM report on Wednesday will also be in focus.
It is also busy in Europe where we get the July report for the euro area consumer price index on Thursday with consensus expecting a +1.0% year-on-year print for the core, up from +0.9% in June. We get the advance Q2 GDP reading for the euro area on Tuesday, with expectations for a +0.5% quarter-on-quarter reading. In Asia the most significant releases will be the China PMIs.
Finally, we expect the earnings season to remain a key driver for equity markets, with Caterpillar the standout on Monday.
Market and economic review
Global earnings growth supportive for equities
We are now two thirds of the way through the US earnings season after 40% of the S&P 500 Index market cap reported this week. It has been a positive earnings season so far with EPS growth now standing at 24% versus pre-season expectations for 20%. This is in line with the Q1 growth rate and even after adjusting for the impact of tax reform (approx. +7%), it represents an acceleration from EPS growth of 12% over the same quarter last year. The proportion of companies beating expectations has also been very high, currently standing at 87%, while market reaction to beats has thus far been more encouraging than was the case last quarter.
While we anticipated strong results given the strength in US economic data throughout Q2 and positive early-reporter trends, our key concern was that management guidance and commentary would be impacted by the ongoing trade disputes. There have been a few examples of this, most notably Ford and General Motors, which cut profit forecasts for this year on surging prices for steel and aluminium. The wider market impact however has been minimal, with the trend of cyclical sector earnings growth outperforming more defensive sectors firmly intact. The sharp reaction to Facebook’s revenue miss and guidance cut (-20%) gathered a lot of headlines, but this reflected more idiosyncratic factors specific to the firm and thus market contagion was limited.
We have also seen strong earnings growth in other regions, with EPS growth in Europe and Japan accelerating from Q1. The levels of growth are not quite as high as in the US, even adjusting for the US tax impact, but share-price reaction has been encouraging. This means that so far this year we have had significant de-rating in valuations of global equities, with accelerating earnings not matched by index-price performance.
Growth data: US GDP accelerates while European PMIs remain stable
In the US, the economic backdrop continues to be one of robust growth, with Q2 GDP growth printing at 4.1%. While this was a small miss on expectations (4.2%), it represents a strong rebound from Q1, where GDP was revised up from 2% to 2.2%. Consumption was particularly strong (4% versus 3% expected), and this combined with the miss in core personal consumption expenditures (PCE) (2% versus 2.2% expected), would hint that the ‘Goldilocks’ environment may yet have a while to run. We do however remain vigilant for any ‘canaries in the coalmine’, with housing data one area of potential concern. New home sales were down -5.3% month-on-month, and we will monitor this series closely to see if this negative trend persists.
Meanwhile, data released in Europe during the week reaffirmed the theme of stabilisation. Provisional purchasing managers’ indices (PMIs), while off the highs, remain in expansionary territory, with the eurozone composite printing at 54.3. While this was a small miss on consensus expectations (54.8), the rebound in the manufacturing PMI to 55.1 is particularly encouraging. The German IFO survey has also stabilised; the headline business climate index moved to 101.7 from 101.8.
Trade: potential for de-escalation, but still plenty of uncertainty
The ongoing tariff dispute between the US and its key trading partners has been the key market focus of late and this week President Trump met with EU Commission President Juncker in Washington. The two sides announced a ‘ceasefire’ in the trade war and US and European equity bourses reacted to this news positively, as one would expect. Specifically, President Trump spoke about an expansion of European imports of US liquefied natural gas and soybeans, while agreeing on lowering industrial tariffs.
President Trump also said that the US and EU were to work towards “zero” tariffs and called it a “new phase” of trade relations, while adding that the two sides would try to “resolve” steel and aluminium tariffs imposed earlier this year by the US. Although these announcements certainly show promising signs of de-escalation, it is worth noting the lack of mention of vehicles/auto parts, which is the biggest area of contention between the two parties. We are also mindful of the positivity that followed President Trump’s meeting with China’s Vice Premier Liu He in May, and how the relations have steadily deteriorated since.
Central banks: media reports ahead of Bank of Japan meeting
Japanese government bond yields spiked higher over the week, putting pressure on government bond yields globally. Markets have become increasingly nervous that the Bank of Japan (BoJ) will announce an adjustment to its quantitative easing programme. A range of media reports suggested a change at its 30-31 July policy meeting was interpreted as intending to prepare markets for a change. An increase in the target for long-term yields, or shifting from a 0% 10-year yield target to an allowable trading band, appear to be the most likely moves.
There was little anticipation ahead of the European Central Bank (ECB) meeting this week and it certainly lived up to this (lack of) hype. President Draghi continued to promote a message of gradual policy normalisation, reiterating that patience is needed to bring inflation towards target and anchoring yields in core markets, with German government bond yields rising only marginally.