Insight Multi-Asset Weekly Update: Anticipation continues to build for a Trump-Xi meeting at the G20 summit

From

Adam Kibble

Market and economic review 

Risk assets lose positive momentum in latter half of the week on global growth concerns, while government bond yields move higher

Risk assets started the week on the front foot following the news late last Friday that the US had agreed to suspend tariff action against Mexico. This early momentum gradually faded through the week, tempered by softer global industrial production prints in Europe and China. Despite this backdrop, global equities finished the week up slightly, with Asian and emerging market equities the outperformers. It is interesting to note that despite the more positive tone in risk assets so far this month, government bond yields continued to fall. Market expectations for central bank policy action that may stabilise growth perhaps explains this divergence.

The US CPI print released this week missed expectations, providing further ‘leeway’ for the Federal Reserve to move towards a looser policy stance. The US 10-year yield rose 3bps this week, now trading at 2.11% while the 10-year German bund yield continues to hover around the all-time low of -0.26%. This lower yield environment has also been supportive for the riskier end of fixed income, with both high yield and emerging market bond spreads tightening on the week.

Chinese activity data was mixed while US retail sales revisions point to pick up in consumption in Q2 GDP

China took centre stage this week with a number of important data points released. For us, the most important of these was the monthly activity data released on Friday morning. Industrial production growth slowed to +5.0% year-over-year in May, from +5.4% in April, while fixed asset investment growth was +5.6% year-to-date in May, a sharp slowdown from +6.1%. Both of these releases were misses on consensus expectations for +5.4% and +6.1%, respectively. In contrast, retail sales growth bounced to 8.6% year-over-year in May, beating consensus expectations for +8.1%. These numbers confirm recent trends that domestic demand in China is holding up better than the industrial sector. This is not unsurprising given that stimulus action thus far has been more targeted towards domestic consumption. That being said, we anticipate that a continued slowdown in industrial growth will not be tolerated for long, and there have been numerous soundbites in recent weeks from Chinese officials indicating a willingness to increase policy support. Monetary growth and credit data for China was mixed, with  M1 growth data beating expectations and new loan growth increasing, but not by as much as expected.       

In the US, we also had both industrial production and retail sales prints on Friday. Retail sales growth was +0.5% month-over-month, just missing expectations for +0.6% growth. However, there were big upward revisions to the March and April reports. This suggests that US consumption looks set for a sharp rebound in the Q2 GDP report. Industrial production also beat expectations, growing at +0.4% year-over-year in April, versus expectations for growth of +0.2%. There was also a decent jump in the May NFIB small business optimism reading of 1.5pts to 105.0 (vs. 102.0 expected). May CPI missed expectations, printing at 0.1% month-over-month, versus 0.2% expected.

In Europe, industrial production remained weak with the April growth rate printing at -0.5% month-over-month while headline inflation in Germany was 1.4% year-over-year in May. Both of these prints were in line with consensus.

US agree to suspend tariffs on Mexico while anticipation continues to build for Trump-Xi meeting at G20

The US announced an agreement with Mexico late on 7 June, ending the short period of uncertainty which had caught markets off guard following Trump’s tariff threats just seven days prior. This provided a boost to risk assets early in the week and the Mexican peso strengthened +2% following the news. Had the full 25% tariffs actually been implemented, the impact on the US economy could potentially have been even more damaging than the ongoing US-China trade dispute. This fact, along with the speed of resolution, throws significant doubt on how credible Trump’s threats ever actually were. Clearly, the incumbent president has an eye on next year’s election and it is becoming more evident that he feels he can use tariffs to paint himself as a ‘great dealmaker’ to his domestic audience.

It would therefore be tempting to extrapolate this showmanship to the ongoing US-China trade dispute. However, the two situations differ in a number of key areas. The first is that a tough stance on China is an entrenched view held across a significant cohort in Washington, generally commanding bipartisan support. The second is that China has shown both the willingness and ability to fight back, whereas Mexico’s dependency on the US economy meant that it had very little choice but to agree to Trump’s somewhat unrealistic demands. There wasn’t too much significant news flow this week relating to the US-China trade dispute; although there were headlines from senior officials on both sides that suggested the two leaders both want to meet at the G20 summit in two weeks.

Politics: chances of a no-deal Brexit increase while Iran tensions drive oil prices higher 

In the UK, there were two developments last week which look to have increased the odds of a no-deal Brexit. The first was a defeat of the Labour motion that would have allowed MPs to take control of the parliamentary timetable on 25 June. The second is the results of the first Conservative Party leadership vote, which showed very strong support for Boris Johnson. In fact, betting odds now imply an 80% chance that ‘Bojo’ will be the UK’s next Prime Minister. Johnson has recently said that if a deal can’t be reached, he would favour a ‘no deal’ exit so as to honour the October deadline.

Outlook

This coming week is particularly busy with numerous central bank meetings and important global growth indicators on the agenda. The Federal Reserve (Fed) meeting on Wednesday will be the key market focus. Market expectations are very much on the dovish side with the Fed funds rate currently implying an 86% chance of a rate cut in the July meeting. This has increased sharply in recent weeks from only 25% at the end of May. We think that it is unlikely the Fed will want to go into July without either confirming or tempering such clear market expectations, so Fed Chairman Jerome Powell’s press conference will be of particular interest. While the weak CPI print this week confirms the Fed has plenty of wiggle room on the inflation front, the strength of retail sales revisions highlights that the US domestic sector still seems to be in good health. Sticking with the central bank theme, both the Bank of England and the Bank of Japan meet on Thursday, while European Central Bank President Mario Draghi is due to speak at the Sintra conference.

The key data release this week will be the June flash manufacturing PMIs on Friday. Regular readers will know the importance we place on these as a real time indicator on the global growth backdrop. Last month saw the aggregate global manufacturing PMI fall into contractionary territory (49.8) for the first time this cycle. This was mostly driven lower by weakness in forward looking components (e.g. new orders) which were impacted by the recent ramp up in trade tensions rather than the output components. This print will see all components impacted by the trade dispute and thus we should get more clarity on the impact of tariffs thus far. 

On the political front, the UK leadership contest should whittle down to two candidates by Thursday while any developments on a potential meeting between Trump and Xi at the G20 will also drive market sentiment.   

By Adam Kibble, investment specialist

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