Insight Multi-Asset weekly update: PMIs for Japan, Europe and the US will remain under scrutiny

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Market and economic review

A Stellar week for government bonds, as longer-dated yields reach record lows

At the start of last week, 30-year US government bonds were yielding 2.25%, having tightened by roughly 75bp since the beginning of this year. To put it in context, that equates to a total return of 24%, roughly 10% more than what the US equities returned over the same time frame. The rally in government bonds showed no signs of respite last week, as 30-year US yields tightened by a further 19 basis points, reaching new lows. Looking at the yield curves across developed markets, there was a noticeable flattening, with longer-dated bonds rallying more than their shorter-dated counterparts. This compression in term premia could be seen as the market’s expression of concerns around long-term growth prospects and a benign inflation outlook globally (more on the data releases below). Although difficult to pinpoint a singular reason, the more recent tightening in core rates could be attributed to weakness in data releases, political uncertainty and a reach for yield. 

Some signs of divergence between different economies as the underlying data continues to moderate on balance

Chinese data continued to show signs of weakness as the latest prints of industrial production (4.8% year-on-year, or y/y) and retail sales (7.6% y/y) came in well below expectations (6% y/y and 8.6% y/y, respectively). Equally disappointing were the details on Chinese credit growth, which showed a noticeable reduction in the number of new loans, as well as the broader money supply. This, being one of the key leading indicators, raises concerns about the health of the broader Chinese economy, which is already facing multiple challenges as a result of the trade debate with the US.

Germany published its latest ZEW survey results, which indicated a sharp decline of 19.6 points. The latest reading at -44.1 is well below expectations of -28, and the largest decline since July 2016. The other highlight was the Q2 GDP reading in Germany, which showed a contraction of 0.1%. Although in line with expectations, this does not help the general sentiment.

In other data releases, French CPI was confirmed at 1.1% y/y and -0.2% month-on-month (m/m), with the upside surprise being the UK CPI, which came in at 2.1% versus an expectation of 1.9% y/y. 

There were some signs of inflation picking up in the US, as the latest CPI report indicated a 0.3% increase m/m, pushing the y/y reading to 2.2%. This is the first instance where two consecutive monthly readings have printed at more than 0.3% since 2001. Looking into the different components of the basket, there were no obvious outliers, which would indicate some broadness in strength of the data. One of the key components that we monitor, with regard to its pass-through to broader inflation, is the unit labour costs. The latest reading of 2.4% indicates a visible increase from its previous level of -1.6% and a consensus of 2%. It is worth noting, however, that this recent uptick had little impact on government bonds, which continued to rally throughout the week. A bigger surprise was the July retail sales release that indicated a rise of 0.7%, well

above the consensus of 0.3%. The details of this report highlight the relative strength of the consumer sector, which in turn, acts as a positive lead indicator for future GDP growth. Another noticeable release last week was the single family permits component of the US housing starts data. Although this series tends to be volatile, the latest reading was the third straight increase in single-family permits, outlining a clear upward trend. One of the underlying reasons for this improvement is the reduction in mortgage rates, which have benefited from falling government bond yields. 

Political headlines continue to weigh on risk assets

The biggest idiosyncratic event for the week was the aftermath of the Argentinian elections, which saw the populist opposition candidate surprisingly beat President Macri in the primary election by a sizeable margin. The immediate reaction saw markets reduce their position in the Argentinian peso, which sold off by almost 16% on Monday. By mid-week, the peso had reached record lows of 60 against the US dollar. This sentiment was visible across all Argentinian assets, where the benchmark stock index fell by 38% – the biggest drop since 1990 – and the country’s 100-year bond is now trading at 51 cents on the US dollar. Nevertheless, the contagion effect from this event on the broader emerging market complex was fairly limited. 

After signs of de-escalation the previous week, there were some positive developments on the ongoing US-China trade debate. On Tuesday, the US administration announced it would delay the implementation of the recently announced 10% tariffs on around $150bn of Chinese imports until mid-December. In a follow-up announcement, President Trump confirmed that the reason behind the delay was to avoid any downside impacts on the Christmas shopping season. Reading between the lines, this could be interpreted as recognition of the negative impact that tariffs could have on prices for the US consumer. Unsurprisingly, risk assets reacted to this announcement with a decent rally on the day.

This week also saw news flow around Italian domestic politics suggesting a coalition between the Five Star Movement and the Democratic Party, an event which has been widely considered improbable.  

Outlook

With the sharp decline in US yields this month, there will be considerable focus on the annual US Federal Reserve (Fed) symposium and the minutes of the July Federal Open Market Committee meeting. Markets will also look out for any associated commentary from the Fed as more than two rate cuts are now expected this year.

Much emphasis has been placed recently on the inversion in government bond yield curves and its efficacy in predicting economic recessions. In that context, economic data releases this week, including the preliminary PMIs for Japan, Europe and the US will remain under scrutiny. With the majority of the manufacturing PMIs already in contractionary territory, this latest set of readings could weigh on risk assets. 

In terms of the political backdrop, any developments in the US-China trade talks are worth keeping a pulse on. Markets will also watch out for any updates from Italy as the prime minister is due to address the senate in Rome.

By Adam Kibble, Investment Specialist

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