Lagarde on the oche

Emily Nicol
Chris Scicluna

Overview:
With the Fed yesterday evening having strongly signalled its desire to sit on the side-lines over coming months, but Jay Powell’s press conference having a rather dovish tone (please see the comment from Daiwa America’s Mike Moran), and no news of any substance on US-China trade, Asian financial markets have lacked new direction today. Equity markets have seen a mix of gains and losses, with the main indices in Korea and Taiwan both up more than 1%, but China’s CSI300 down 0.3% and Japan’s TOPIX down marginally as the latest Japanese machine orders data came in significantly weaker than expected (see below). So, while USTs were a touch weaker, essentially reversing their modest gains made in the aftermath of the Fed’s announcements, JGBs were slightly stronger (10Y yields down 1.6bps to close to -0.03%). In Europe, most euro area govvies have opened slightly higher ahead of Christine Lagarde’s first post-policy meeting press conference at lunchtime today, while sterling’s up yet again as UK voters go to the polls.

Japan:
Just as recent consumption and production data have implied a steeper than anticipated drop in economic activity in Japan at the start of Q4, today’s release of October’s machinery orders figures also disappointed. In particular, private sector core orders – which offer a guide to private sector capex three months ahead – fell for the fourth consecutive month and by a steeper-than-expected 6.0%M/M, leaving them down more than 6% compared with a year earlier and at their lowest level for more than four years. In response, the Cabinet Office revised down its assessment of the data, judging that orders were now at a standstill.

Within the detail, there was further weakness in orders placed by manufacturers, which declined for the fifth month out of the past six and by 1½%M/M, to leave them more than 15% lower than a year ago. This in part reflected exceptional declines in certain subsectors, including a 44%M/M drop in ICT equipment. In contrast, other key export-oriented sectors – i.e. electrical machinery and autos – recorded an increase in orders at the start of Q4. There was a more notable decline in orders placed by non-manufacturers in October (-5.4%M/M), although this principally reflected a near-29%M/M drop in the transportation subsector. And overall, orders in the sector were still almost 3% higher than a year earlier.

Orders data are, of course, notoriously volatile. And October’s data are more difficult than normal to interpret given the additional complications of the consumption tax hike and the impact of the super typhoon. Nevertheless, despite a likely rebound over coming months, we would expect domestic orders to fall short of the Cabinet Office’s forecast growth of 3½%Q/Q in Q4 – indeed, this would require hefty increases of circa 6½%M/M in both November and December. However, public sector orders rose 40.8%M/M in October. That still left them down a sizeable 14.0%Y/Y. But we would expect to see a further boost in this category over coming quarters from the government’s fiscal stimulus package. And foreign orders rose 2.9%M/M in October to be up 10.0%3M/3M, the firmest rate so far this year, to suggest an improvement in the external demand environment too.

Euro area:
Today brings the main euro area event of the week in the shape of the ECB policy announcement and first post-Governing Council meeting press conference from Christine Lagarde. The meeting will also coincide with publication of the ECB’s updated macroeconomic projections. However, we do not expect significant amendments to be made to the previous set of forecasts, published in September, which anticipated a gradual pickup in GDP growth and inflation over coming quarters.

And we expect the projections for 2022, to be published for the first time, to suggest that inflation that year will be below but close to 2.0%Y/Y, i.e. essentially consistent with the ECB’s target.

At the previous meeting in October, however, several members raised concerns that the projected pickup in growth and inflation might not materialise. So, Lagarde is still likely to echo Draghi’s previous warnings that the risks to the outlook remain skewed to the downside. And there should be no case whatsoever to amend policy. Nevertheless, the new President might well have new ideas regarding the forward guidance, which currently states that “the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon and such convergence has been consistently reflected in underlying inflation dynamics”.

With the ECB set shortly to commence a review of its monetary policy strategy, however, it might seem premature to amend the forward guidance just yet. Nevertheless, Lagarde’s comments in her post-meeting press conference – not least regarding her current assessment of the possible negative side-effects of the ECB’s current policy stance, and her readiness (or otherwise) to ease policy by adjusting any/all of its policy tools – might inject a slight dose of volatility into the markets today, particularly if they offer more than just a hint of what to expect from the outcome of the strategic review.

More prosaically, in terms of data, today will bring euro area industrial production figures for October. Despite an improvement in France, falls in production in Germany, Italy and Spain suggest that aggregate euro area output declined around ½%M/M at the start of Q4, leaving it still almost 2½% lower than a year earlier. Separately, we have already seen the final November inflation estimates from Germany and France, which aligned with their respective flash estimates, both 1.2%Y/Y on the EU-harmonised measure.

UK:
Of course, the main event in the UK will be the General Election. But there will be no new insights offered throughout the course of the European trading day – the first information on the likely outcome will be the exit polls published as soon as polling stations close at 10pm GMT. The results from individual constituencies will be published throughout the night, hooever, so that the overall result will likely to be clear well before European markets reopen tomorrow morning. Over the past week or so, investors have firmed up their expectation of a Parliamentary majority for PM Johnson’s Conservatives, as, on average, opinion polls suggest that the party’s lead over Labour is still as much as 9ppts. Given the margins of error on these polls, however, it remains within the bounds of possibility that the Conservatives will fall short of a majority, which would then open the door to a minority Labour administration. (We attach a probability of 75% to a Conservative majority.)

A majority for the Conservatives would mean that the UK would leave the EU at end-January and then enter a Brexit ‘implementation’ phase, which Johnson insists would conclude at the end of 2020. However, as it would be difficult for a new Free Trade Agreement between the UK and EU to be agreed and ratified before then, the risk of a highly costly WTO exit – implying the imposition of tariffs and non-tariff barriers to trade – at the end of next year would persist. The associated uncertainty would thus continue to weigh on business investment, which has flat-lined since the 2016 referendum. And so, we would expect UK GDP growth to remain very subdued, meriting an easing of monetary policy. Therefore, while a Conservative majority might well see sterling appreciate further (it’s up again to above $1.320 this morning) and Gilt yields rise too, we would expect those effects to reverse once again in the New Year as the continued weakness of economic activity became evident.

If there is a minority Labour administration, the new Government would need to seek a further extension of the Article 50 deadline beyond end-January to accommodate a second Brexit referendum around mid-year. It would also try to rapidly negotiate an alternative softer Brexit deal to be subjected to that referendum. The near-term impact on sterling and Gilt yields would be negative, all the more so given Labour’s pledges to significantly increase both public current spending and taxes and its aggressive plans for renationalisation of utilities. The near-term economic outlook would also likely be no better than under the Conservatives as uncertainty persists. However, a minority Labour administration would not be able to implement the most radical measures within the Party’s manifesto. And the possibility that Brexit might eventually be cancelled would represent upside future potential for sterling and economic growth.

While of secondary importance, this morning brought the RICS Residential Market Survey results for November. Unsurprisingly given the heightened political uncertainty, new buyer enquiries and new selling instructions were down again too to suggest weakness on both the demand and supply side of the market. But conditions are expected to improve gradually, with the net balance for expected sales in three months’ time edging up to 11%, and average twelve-months sales expectations rising for a third month in a row and suggesting that a net 35% of survey respondents (the most since February 2017) expect sales to increase this time next year. In terms of prices, following three broadly flat readings, the headline price balance fell to -12%, a level suggestive of a modest decline in average house prices at the national level albeit once led by London and the South East. Near-term price expectations are relatively flat, but a net balance of 33% of respondents expect house prices to pick up over the coming twelve months.

US:
In the US, it should be a quieter day for economic releases with the latest weekly jobless claims figures to be accompanied by November PPI data and the Fed’s latest flow of funds numbers for Q3.

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