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The week ahead

By David Morrison  |  19/10/2018 12:48
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The third quarter earnings season steps up a gear while global equity markets remain volatile. Problems for US/China persist as do those for Europe with Brexit and Italy in focus

Next week the US third quarter earnings season steps up a gear with a flood of significant corporations reporting. These include Halliburton, Caterpillar, Verizon, McDonald’s, Microsoft, Boeing, Ford, Coca-Cola, Merck, Alphabet (Google) and Amazon.

Forward guidance

By the end of next week, we’ll probably have a good idea if this season is going to be strong enough to help push markets higher. The concern is that even if earnings and revenues surprise to the upside overall, any disappointing forward guidance may indicate that we’re reaching the cycle peak. From here on in the year-on-year comparisons get tougher and the positive effects of the Trump tax cuts and repatriation of overseas earnings fade rapidly.

ECB and GDP

Next week there are no significant economic data releases until Wednesday when we have the Flash Manufacturing and Services PMIs from France, Germany, the Euro zone and US, along with a monetary policy meeting from the Bank of Canada. On Thursday the European Central Bank (ECB) is expected to keep its Main Refinancing Rate unchanged at zero. But the focus will be on Mario Draghi’s subsequent press conference to see if the ECB President still plans to end the Asset Purchase Programme at the end of this year. On Friday we have the first look at third quarter GDP from the US. This is expected to rise 3.3% annualised, down from the 4.2% increase recorded in the second quarter.

Yuan under pressure

Yesterday’s commentary (18/10/2018) focused on the fall in the Chinese yuan which saw the onshore (official) USDCNY end the session at its highest level (lowest yuan rate) since January 2017. The move was concerning as the USDCNY inched closer to the 7.00 level, considered by many analysts to be a ‘red line’ as far as the Trump administration is concerned. The sell-off in the yuan came despite Wednesday’s release of the US Treasury’s biannual FX report in which the Treasury held back from designating China a currency manipulator. Nevertheless, any further weakening is likely to result in shouty tweets from President Trump, ready to accuse China of deliberately pushing the yuan lower to offset the effects of tariffs on US imports from the Middle Kingdom.

Chinese growth slows

The yuan gained a touch in Friday’s Asian Pacific session even after third quarter Chinese GDP slipped to +6.5% year-on-year, below the +6.6% growth anticipated and the lowest reading since the +6.1% recorded since the first quarter of 2009. Chinese equities also surged, with the Shanghai Composite ending the day 2.58% higher, reversing most of the losses posted on Thursday. The push higher came after the People’s Bank of China (PBOC) along with the regulatory commissions for both securities and banking/insurance stepped in with soothing words of support. The three entities sought to calm investor fears while the China Securities Regulatory Commission promised reforms to boost investment. These actions seem to have done the trick, although a bounce-back was overdue anyway given that equities and the yuan looked oversold. But the big test will come over the next few weeks. If the selling resumes, then the Chinese authorities will be forced to take more aggressive measures (as they did in August 2015) to force investors from bailing out.

Hawkish Fed

But while the continued slowdown in Chinese economic growth is a major factor in the yuan’s decline and the loss of confidence in China’s equity market, it’s not the only one. Adding to the yuan’s weakness (US dollar strength) was the release on Wednesday of minutes from the Federal Reserve’s monetary policy meeting on 25th-26th September. This was when the Federal Open Market Committee (FOMC) raised rates by another 25 basis points, taking the headline fed funds rate into a range of 2.00-2.25% - the highest level since March 2008. The minutes were interpreted as hawkish, as several officials saw the need to hike rates above the long-run level. Three members now see inflationary risks skewed to the upside while no members believe there are downside risks. Some participants talked about risks associated with a stronger dollar and stresses in emerging markets while a few committee members expressed concern about the growth of the leveraged loans market, something which has echoes of the derivatives fiasco which exacerbated the Great Financial Crisis. Certainly, global debt levels are extraordinarily high. While there is less concentration on leveraged borrowing linked to housing, it’s corporate America (along with emerging markets of course) which has taken the opportunity of historically-low interest rates to load up on debt. This becomes a problem as US rates ‘normalise’ and corporations are forced to pay more in interest to roll over their borrowings.

Problems in Europe

Meanwhile, the Brexit situation continues to baffle and frustrate, with speculation brewing that a ‘no deal’ deal is increasingly likely. Despite this, sterling remains relatively resilient despite giving back some of last week’s gains. At the same time, the new Italian coalition government is preparing to face down the European Commission (EC) over its deficit-busting budget proposals. No matter how hard the EC pushes back and threatens Italy, it’s clear that it is applying different standards in its approach to Italy’s spending plans to those of France or Spain. This will only harden the resolve of the Italian government and raises the probability of a full-blown crisis. Italian bond yields rose again on Friday reflecting investor concern.  


 
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