Weekly look-ahead

By David Morrison  |  25/05/2018 15:10

This article looks forward to next week’s US Non-Farm Payroll release and backwards at market-moving events such as monetary policy and geopolitics
 
Look-ahead

It’s a holiday-shortened week with Bank Holidays on Monday for both the UK and US. Nevertheless, it’s a big one for major economic data releases with US Non-Farm Payrolls being the highlight on Friday. We’ve now seen two disappointing jobs numbers on the trot, so the hope is that headline payrolls will bounce back above 180,000. Once again, the Unemployment Rate is expected to come in around 4.0%, the lowest levels seen for over 17 years. But all eyes will be on Average Hourly Earnings as a bigger-than-expected pick-up here will once again increase concerns that inflation is rising more sharply than currently forecast.

We get another key piece of US inflation data on Thursday with the release of Core PCE. This is the Fed’s preferred inflation measure and is within a whisker of hitting the US central bank’s 2% target. However, as shown in the release of minutes from the Fed’s last monetary policy meeting, it has become apparent that the FOMC is prepared to see inflation push substantially above target without the Fed feeling the need to raise rates at a more aggressive pace. The danger here though is to do with the rate of change. A slow and steady pick-up in inflation is fine (as far as investors are concerned) particularly if accompanied by solid GDP growth. But a spike higher in prices, wages and other key inflation components could spook traders and investors alike. This is particularly the case as oil (which is excluded from ‘core’ inflation measures) continues to make fresh multi-year highs. Some analysts are becoming concerned that the central bank could lose control of prices given all those years of extraordinarily easy monetary policy. This could lead investors to reassess the likelihood of the Fed having to raise rates much more aggressively than currently forecast.

Overview

Monday saw a strong start for equities with all the major indices gapping higher. This followed on from last weekend’s statement from US Treasury Secretary Steven Mnuchin of a halt in the US/China “trade war”. (Funny, we thought it was just a dispute). But there were some warning signs as the “euphoric buying” which greeted last weekend’s news may have been overdone. Prices fell back after Trump expressed dissatisfaction with trade talks and then cast doubt on the likelihood of a meeting with North Korean leader Kim Jong-un scheduled for 12^th June. This came to a head when President Trump wrote that the North Korean president’s “tremendous anger and open hostility” was his reason for calling off next month’s talks.

Last week the two main Italian Eurosceptic parties, Northern League and Five Star Movement, reached agreement to form a coalition government. This was officially sanctioned on Thursday by President Sergio Mattarella after he approved Giuseppe Conte as Prime Minister. This means that Italy could now governed by two Eurosceptic parties who appear determined to face down Brussels and blow out the country’s budget. 

On top of this there’s the ongoing Emerging Market meltdown led by the slump in the Turkish lira and driven by the continued rally in the US dollar. The EURUSD fell below support around 1,1700 following the release of unexpectedly weak PMIs from across the Euro zone. Then minutes from the Fed’s last FOMC meeting showed that members were fairly evenly split over the likelihood of either two or three further 25 basis point rate hikes this year. They are also prepared to see inflation run above their 2% target.
On Thursday the ECB the released minutes from its last Governing Council meeting. Members noted that uncertainty around the outlook had increased since the March monetary policy meeting and that "a more pronounced weakening of demand, notably related to external factors, could therefore not be ruled out."

Weakness in both the euro and British pound helped to keep a bid under the German DAX and FTSE100 for the first half of last week. However, both indices pulled back sharply heading into the weekend. Meanwhile, the S&P500 has repeatedly failed to break above resistance around 2,740. This level is just a touch below the 61.8% Fibonacci Retracement of the sharp drop in the first week of February this year.
 
FOREX

The US dollar continued to plough higher this week and the Dollar Index hit its high for the year. The greenback has got a lift from the yield advantage it has over other major currencies such as the euro, yen and sterling. However, minutes from the Fed’s last monetary policy meeting made it clear that the Federal Open Market Committee (FOMC) is prepared to let inflation overshoot its 2% target without accelerating its pace of monetary tightening. If inflation continues to pick up and head towards 2.5% or even 3% this year then ‘real rates’ will go increasingly negative. This should take some of the steam out of the dollar’s rally and we’ve already seen a sharp pull-back in the 10-year US Treasury yield.

Offsetting this was a rash of negative news for the euro. There are concerns that the two Eurosceptic Italian parties who look set to form a coalition government are on a collision course with the European Union. In addition, the single currency came under further selling pressure following the release of a clutch of disappointing Services and Manufacturing PMIs from across the Euro zone. The IHS Markit Euro zone Composite PMI fell to 54.1 in May from 55.1 in the previous month, below the 55.0 expected. This was the slowest expansion in private sector activity since November 2016 and displays a worrying downward trend. This has added to concerns that the Euro zone GDP growth may not bounce back after recording a disappointing quarter-on-quarter reading of just +0.4% for the three months to March 2018. The news makes it even more difficult for the European Central Bank (ECB) to produce a detailed roadmap for further winding down its Asset Purchase Programme. St the same time, US Manufacturing and Services PMIs both increased from the prior month, further emphasising the divergence between the US and euro zone economies. This only helped to encourage traders to increase their exposure to the dollar. The next major support level for the EURUSD comes in around 1.1600 – the ‘head’ of last year’s inverse ‘head and shoulders’ pattern.

The GBPUSD continues to come under selling pressure. Having now broken below 1.3400, there’s some modest support around 1.3300 although 1.3200 looks like a more robust level for a possible rebound. Cable is looking increasingly oversold. However, recent UK economic data releases (such as Friday’s revised first quarter GDP and Wednesday’s softer inflation data) have disappointed giving the Bank of England’s Monetary Policy Committee plenty of reasons for delaying further rate hikes. Not only that, but the UK government’s botched Brexit negotiations is further cover for the Bank to keep monetary policy loose. Sterling may be well overdue a bounce, but it will need some bad news for the US dollar to help it along.

Crude oil
 
On Tuesday both Brent and WTI hit their highest levels since November 2014. However, both contracts have fallen sharply since then with the bulk of the losses suffered going into the long holiday weekend. Sellers piled in following reports that Saudi Arabia and Russia had discussed reducing the OPEC/non-OPEC production cut agreement from 1.8 million barrels per day (bpd) to 800,000 bpd. There had been plenty of speculation this year that Russia would push for the output cut to be modified as global oil inventories fell back towards their 5-year average. Next month’s OPEC meeting was thought to be the venue for an announcement. However, it was also thought that Saudi Arabia (the world’s third largest producer after Russia and the US, and unofficial lead county of OPEC) would push back against modifying the agreement, particularly ahead of the proposed Saudi Aramco IPO, expected sometime in the next 12 months. However, production in Venezuela has fallen sharply as the country struggles with a collapsing economy and US-led sanctions against Iran should also dent supply significantly – perhaps by 500,000 bpd. Both countries are members of OPEC.
Meanwhile, there has been talk that the US shale boom has been overhyped. There’s no doubt that US production has risen dramatically over the last five years or so, but there’s also a lack of infrastructure to move the oil to where it needs to be. This means that shale sells at a discount to other crude and this in turn discourages fresh investment.
Friday’s sell-off was also exacerbated by excessive long-side positioning by large speculators. These players rushed to cover their longs as prices fell.

Precious metals

Gold appears to have stabilised. This follows a vicious sell-off on 15^th May which saw the price slump below its 200-day simple moving average (SMA) and hit its lowest level since December last year. However, it managed to hold on to support around $1,285, a level which corresponds to the 61.8% Fibonacci Retracement of the December 2017 – January 2018 rally. It spiked higher on Thursday after President Trump cancelled his planned 12^th June summit with North Korean leader Kim Jong-un. The rally took the gold price back above $1,300 although it has so far failed to break above the 200-day SMA around $1,307. Nevertheless, gold bulls should be feeling happier now and relieved that the plunge from earlier in the month didn’t develop into something more serious. They will also look for $1,285/90 to hold as support going forward.

Meanwhile, silver continues to trade in a relatively tight range. We’ve seen $16.20 act as solid support for all this year while $16.80 has offered decent resistance since February. The only failure came in mid-April when a false breakout saw silver trade above $17.30 only to slump back within the range just a few days later.

Both precious metals should benefit from any further uncertainty over the global geopolitical situation. However, they may find it difficult to make much upside if the dollar continues to rally. The gold/silver ratio (the price of an ounce of gold divided by an ounce of silver) has dropped back below 80. This suggests that silver is less of a bargain relative to gold than it was earlier in the year. Nevertheless, the ratio remains high by historical measures suggesting that a further narrowing of prices should occur over time.
 
 
 
Key events next week

Monday -             Bank Holidays – UK and US

Tuesday -             EUR M3 Money Supply; USD S&P/Case Shiller HPI, Consumer Confidence

Wednesday -     EUR German Import Prices, German Preliminary CPI, French Preliminary GDP, Spanish Flash CPI, German Unemployment Change; USD ADP Non-Farm Employment Change, Preliminary GDP, Fed Beige Book; CAD BOC Rate Statement

Thursday -           CNY Manufacturing and Non-Manufacturing PMIs; EUR German Retail Sales, French Preliminary CPI, Euro zone Flash CPI; GBP Net Lending, M4 Money Supply, Mortgage Approvals; USD Core PCE, Personal Spending, Personal Income, Weekly Jobless Claims, Chicago PMI, Crude Oil Inventories

Friday -                 CNY Caixin Manufacturing PMI; EUR Spanish, French, German and Euro zone Manufacturing PMIs; GBP Manufacturing PMI; USD Non-Farm Payrolls, Average Hourly Earnings, Unemployment Rate, Construction Spending, Total Vehicle Sales.
 
 
 
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