Weekly look-ahead

By David Morrison  |  09/03/2018 16:16

Risk markets bounce back on strong jobs data and dismiss Trump’s tariffs

Summary

We get a break from central banks this coming week giving investors an opportunity to take stock before a key meeting of the US Federal Reserve on 21^st March. But there are still a few economic data releases which have the potential to move markets with US CPI on Tuesday followed by Retail Prices on Wednesday. Both these numbers are important given that the outlook for US inflation is one of the main factors currently troubling investors.

On Friday the latest batch of employment data provided investors with a bullish message – for equities if not for bonds. The headline payroll number smashed above the high end of expectations with a gain of 313,000 jobs in February against a forecast rise of 205,000. There were also sharp upward revisions to the previous two monthly readings. On the face of it the data suggests continued economic strength with the Unemployment Rate steady at 4.1% - equalling its lowest level for over 17 years. But all eyes were on wage growth. Remember that it was an unexpected pick-up in wages a month ago which contributed to the dramatic sell-off across global indices. Bond yields and stock market volatility spiked higher as investors reassessed their forecasts for monetary tightening from the Federal Reserve on fears that the US central bank could be falling behind the curve when it came to hiking rates. But on Friday Average Hourly Earnings for February rose 2.6% year-on-year – down from the +2.9% recorded previously, and undershooting predictions of a 2.8% increase. US stock index futures surged higher in response. However, US Treasury yields also rose sharply suggesting that, as far as bond investors are concerned, fears of inflation and the Fed’s likely response haven’t gone away.

Bear in mind that Jerome Powell has replaced Janet Yellen as Chairman of the Federal Reserve. Mr Powell is thought to be more relaxed than other Fed heads from the past 30 years about the prospect of a significant correction in stock prices. He has previously commented about the Fed’s culpability in encouraging risk-taking by investors desperate for a return in a low-yield environment. Not only that, but the composition of the Fed’s FOMC is easily more hawkish than it has been for years. As an indication of this, little over a week ago New York Federal Reserve President Bill Dudley’s commented that four 25 basis-point rate hikes in 2018 would still represent gradual tightening. Add in the Trump administration’s unfunded tax cuts, spending plans and tariff proposals and it’s no wonder the market is increasingly convinced that we’ll see the Fed hike rates by 100 basis points before the year-end. But as this comes against a background of a rising budget deficit and record national debt, and as the Fed reduces its balance sheet, perhaps investors should be wary on taking on excessive upside exposure to risk assets.
 
Stock indices
 
Last week investors were doing everything possible to throw off concerns over the imposition of US tariffs on imports of steel and aluminium. They seemed determined to play down the potential economic damage of a full-blown trade war, betting that Trump was bluffing and that cooler heads in the White House would prevail. This optimism evaporated midweek after Gary Cohn, Trump’s chief economic advisor, stepped down. However, buyers soon poured back in and sent the US majors flying higher ahead of Friday’s key Non-Farm Payroll report. The impetus came from stories that tariffs would be targeted, with confirmation that Canada and Mexico were exempt, and following news that President Trump had accepted an invitation to meet North Korea’s Kim Jong-un. This could result in a breakthrough in relations between the two countries with hopes that North Korea may wind back its nuclear ambitions.

Last week’s monetary policy meetings from the European Central Bank (ECB) and Bank of Japan (BOJ) did much to calm investor fears that the world’s major central banks were all set to wind down stimulus simultaneously. While the ECB did remove the easing bias language in its statement, it was clear that the central bank is keeping its options as open as it can in terms of extending its Asset Purchase Programme (APP) beyond this September. Yet analysts are speculating that it still wants the APP to end this year with purchases reduced to €10 billion per month in the fourth quarter, down from €30 billion currently.

Meanwhile, the BOJ maintained its programme of Quantitative and Qualitative Easing (QQE). Governor Kuroda made it clear that this will remain in place until the central bank’s inflation target is met which means no exit for the foreseeable future. This was a complete repudiation of the governor’s recent announcement that the central bank would begin planning an exit from its monetary stimulus programme around April next year. So all-in-all it appears that the financial markets will continue to benefit from central bank largesse.
 
Key events

Monday -             USD Federal Budget Balance

Tuesday -             German and Euro zone ZEW Economic Sentiment surveys; GBP Annual Budget release; USD CPI; JPY BOJ Monetary Policy Meeting minutes

Wednesday -     CNY Industrial Production, Fixed Asset Investment, Retail Sales; EUR Eurogroup meetings; USD Retail Sales, PPI, Business Inventories, Crude Oil Inventories

Thursday -           AUD RBA Bulletin; CHF PPI, SNB Monetary Policy Assessment; EUR ECOFIN Meetings; USD Import Prices, Unemployment Claims, Empire State and Philly Fed Manufacturing indices

Friday -                 EUR CPI; GBP BOE Quarterly Bulletin; USD Building Permits, Housing Starts, Capacity Utilisation, Industrial Production, Consumer Sentiment, Inflation Expectations

The fourth quarter corporate earnings season is coming to a close but this week’s significant releases include Adidas, Adobe Systems, Antofagasta, Cairn Energy, Deutsche Lufthansa, JD Wetherspoon, RWE, Tiffany and Volkswagen
 
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