Morning comment: After the Fed

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
Wall Street opened in a ‘risk on’ mood on Wednesday, bolstered by the previous day’s better-than-expected commentary from Apple and a Boeing report that also bettered market expectations. Going into the FOMC’s announcement the S&P500 was already up about 0.8% and Treasury yields and the US dollar were modestly firmer. And then, of course, the Fed proved to be significantly more dovish than many had anticipated, most notably suggesting at a minimum a lengthy pause to tightening, and perhaps even that the tightening cycle could be over.

In particular, the Fed replaced its previous reference to the likelihood of “some further gradual increases in the target range for the federal funds rate” with a more neutral comment that “in light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate”. And during the post-meeting press conference Chair Powell refused to be drawn on whether this implied that the next move in rates is more likely to be down than up.

As regards the economy, the Fed stated that it “continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes”. But the Fed removed the previous comment that “risks to the economic outlook are roughly balanced”, suggesting that it regards the risks, if anything, to be weighted to the downside. During the press conference Powell emphasized “cross currents” that had increase the risk of a less favourable economic outlook, alluding to the slowing of growth in China and Europe, political risks including Brexit, a tightening of financial conditions and ‘muted’ inflation readings (including the impact of lower oil prices). Powell said that the Fed felt that all these factors justified greater “patience” in setting monetary policy, and indicated that the uncertainty associated with these factors could last a while. In other words, policy settings are indeed unlikely to change for some time.

Added to all that, the Fed shifted its tone on balance sheet normalization, attempting to make clear that its redemptions of Treasury securities are not on autopilot, and – while no firm decisions have yet been made in this respect – implying that the Committee might not be far from a portfolio size that might be judged normal. 

In light of the Fed’s dovish commentary Wall Street roughly doubled its pre-meeting gain, with the S&P500 eventually closing up 1.55%. Treasury yields rallied and the curve steepened, with the 2Y yield down 6bps to 2.51% at the 10Y down 3bps to 2.68%. Credit spreads narrowed, commodities firmed and the US dollar weakened, with EURUSD touching 1.15 and USDJPY falling below 1.09.

Since the Wall Street close there have been a number of additional earnings reports released by major US corporates. Following these reports Microsoft stock fell more than 2% in extended trade, but Facebook has rallied more than 10%. And, not surprisingly, the positive backdrop provided by Wall Street and the dovish Fed generated a positive reaction in Asian asset markets, buttressed by some local economic data that was not quite as weak as the market had expected. In Japan, the TOPIX rose 1.1% despite the firmer yen and as IP fell less in December than the market had expected (more on this below). China’s CSI300 also rose 1.1% and Hong Kong’s Hang Seng is currently up by a similar amount following a slight improvement in China’s official PMI readings in January (more on these below too). Much smaller gains were see in markets in Singapore and South Korea, while Australia’s ASX200 bucked the trend and posted a 0.4% decline amidst a stronger Australian dollar. In bond markets, there was little change in the JGB market despite the earlier rally in the Treasury markets, while Australian bonds also underperformed Treasuries as investors continued to digest the previous day’s firmer-than-feared CPI report.

Perhaps unsurprisingly, euro area govvies and equities alike are opening higher. Meanwhile, coming after a very weak German retail sales report this morning, the first estimate of Spanish Q4 GDP surprised on the upside ahead of the release of the euro area and Italian figures later today. The US will see the usual weekly claims and new home sales figures.

Japan:
The main domestic focus in Japan today was on the IP report for December, casting further light on the size of an expected rebound in GDP during Q4. After declining 1.0%M/M in November – albeit following a 2.9%M/M rebound in October – industrial output edged down 0.1%M/M in December. This outcome was modestly better than pessimistic market expectations (0.5%M/M decline had been expected according to Bloomberg’s survey of analysts), although this still leaves output down an unadjusted 1.9%Y/Y. Calculated using the less volatile seasonally-adjusted series, the annual decline in output amounted to an only slightly less disappointing 1.0%Y/Y. Even so, coming off the poor performance seen during Q3 – a 1.4%Q/Q decline in output, not least due to the influence of a number of natural disasters – output still rose a solid 2.0%Q/Q in Q4, indicating that the industrial sector will be a solid contributor to a rebound in overall GDP during the quarter.

Turning to the details of the report, the industry breakdown revealed a 3.0%M/M decline in output of production machinery (down 7.8%Y/Y), while sizeable declines were also registered in production of electronic parts and devices (down 2.6%M/M), chemicals (down 3.5%M/M) and energy products (down 2.5%M/M). Those declines were partially offset by a partial rebound in production of general purpose machinery (up 6.0%M/M and 1.9%Y/Y), and increased production of electrical machinery (up 3.1%M/M) and transport equipment (up 0.7M/M). Shipments rose a modest 0.3%M/M in December but were nonetheless still down 2.8%Y/Y. Inventory levels rose a disconcerting 1.0%M/M and were up 1.3%Y/Y. By sector, the largest annual increases in inventories were seen in electronic parts and devices (24.0%Y/Y), general purpose machinery (up 15.1%Y/Y) and non-ferrous metals (up 10.7%Y/Y). Inventories of motor vehicles fell 11.3%Y/Y. Meanwhile, the overall inventory-shipments ratio rose 2.2%M/M and was up 4.6%Y/Y in December – a development that would typically not bode especially well for production over the near-term at least.

Be that as it may, and despite the stagnation suggested by the preliminary manufacturing PMI report for January, METI chose to retain its assessment of the manufacturing sector i.e. “Industrial production is picking up slowly”. In this regard, METI may have some heart from the latest survey of manufacturers which at face value points to a further gain in output during Q1. In aggregate, firms forecast a further modest 0.1%M/M decline in output in January – an improvement on the 0.8%M/M decline that firms had forecast last month – followed by a 2.6%M/M lift in output in February. If those gains were to be realised, and assuming no revisions, then output would grow a little over 1%Q/Q in Q1. However, given the tendency of firms’ forecasts to be far too optimistic – METI expects firms’ forecast to translate into a more than 2%M/M decline in output in January – we think that output will do well to remain broadly flat in Q1. Indeed, with the manufacturing PMI output index falling to a preliminary 49.2 in January, a modest decline in output seems more likely.

In other news, housing starts edged up 0.6%M/M in December – a marginally firmer result than the market had expected – and so were up 2.1%Y/Y. As a result, the number of starts rose 0.5%Q/Q in Q4.

Euro area:
Thursday will bring the first estimate of euro area GDP in Q4, with the headline growth rate expected to be unchanged from the previous quarter at 0.2%Q/Q. That would leave the annual growth rate in Q4 at 1.2%Y/Y, 1.5ppts lower than a year earlier. Italian GDP is expected to show a second consecutive quarterly decline of 0.1%Q/Q, which would confirm a technical recession in the country, leave the annual rate at just 0.3%Y/Y, and add to doubts about the appropriateness of the Government’s fiscal forecasts. More happily, however, Spanish GDP surprised on the upside this morning, with growth up 0.1ppt from Q3 to 0.7%Q/Q, to leave the respective annual rate unchanged at a very respectable 2.4%Y/Y. Within the detail, the improvement in Q4 in part reflected a notable rebound in export growth (1.9%Q/Q, the firmest for two years), while government spending (1.2%Q/Q) also provided a modest boost, posting the strongest growth since Q115. Household consumption growth (0.5%Q/Q) was a touch weaker than in Q3, while private investment (-0.2%Q/Q) contracted for the first quarter in six.

Ahead of tomorrow’s euro area flash CPI release, the preliminary estimate of French inflation was also published this morning. In line with expectations, this showed a drop of 0.5ppt from December in the annual rate of CPI on the EU measure to an eleven-month low of 1.4%Y/Y. In Spain, meanwhile, the flash inflation estimate came in below expectations, with the EU-harmonised rate down 0.2ppt to 1.0%Y/Y in January, its lowest for a year, adding to evidence that tomorrow’s euro area figure will show a further drop from December’s reading of 1.6%Y/Y despite yesterday’s stable number in Germany (1.7%Y/Y).

But perhaps most striking of this morning’s releases was Germany’s retail sales report, which, against the backdrop of low unemployment and relatively high consumer confidence, was a shocker. While a decline in sales was expected following strong growth in October and November, the 4.3%M/M drop was the steepest since mid-2007 and left sales (on an unadjusted basis) down more than 2% compared with a year earlier. Nevertheless, this still left sales up over the fourth quarter as a whole, albeit by just 0.1%, a disappointing rebound following the 0.6% decline in Q3. And so, today’s release further raises uncertainties about the strength of private consumption heading into the end of last year, with risks to our GDP forecast of 0.2%Q/Q skewed to the downside. Later this morning we’ll also see December unemployment figures for the euro area as a whole, as well as German unemployment figures for January.

UK:
This morning’s GfK consumer confidence survey suggested that UK household sentiment was weak and stable at the beginning of the year. The headline survey index moved sideways at -14, which was still nevertheless the lowest level since around the middle of 2013. Consumers’ assessment of their personal finances improved very slightly. But, despite the tight labour market and higher wage growth, the survey’s forward-looking component remained at the bottom of its recent range. Morever, consumers thought that the economic situation had worsened again and their expectations for the year ahead were at the lowest level since the end of 2011 and indeed the second-lowest since the global financial crisis. Recent consumer sentiment surveys from other major European economies have also showed a significant weakening, but in the UK’s case Brexit is unsurprisingly the major factor causing concern. Indeed, with less than two months to go until Brexit Day on 29 March, all major scenarios remain possible, and consumers appear to be uneasy about the economic damage the ongoing uncertainty is causing.

The Lloyds Business Barometer, also released this morning, failed to bring good news too, with business sentiment remaining very subdued this month. The survey headline index for January was only slightly higher, at 19, up from the joint lowest level since mid-2016 of 17 seen in December. Meanwhile, the Nationwide house price index remained consistent with very weak momentum in the housing market suggesting that UK house prices rose only 0.1%Y/Y in January, the slowest pace since early 2013.

US:
As the dust settles on the FOMC meeting and trade talks conclude, data-wise the latest US weekly claims figures are due along with the Chicago PMI survey for January, new home sales numbers for November (previously postponed due to the shutdown) and the employment cost index for Q4.

China:
The focus in China today was on the release its official PMI reports for January, especially in light of the disappointing decline reported last month. The official composite PMI rebounded 0.6pts to a 4-month high of 53.2, largely reflecting stronger conditions in the non-manufacturing sector. The closely-watched manufacturing PMI edged up just 0.1pts to 49.5, entirely due to a stronger reading at large firms (the PMIs for medium- and small-sized firms weakened further). Within the detail, the production index edged up 0.1pts to 50.9, but the overall new orders index fell a further 0.1pts to 49.6 – the lowest reading since February 2016. The export orders index stood at a contractionary 46.9, albeit up 0.3pts from last month’s low.

As noted, the news outside of the manufacturing sector was more encouraging, with the non-manufacturing PMI rising 0.9pts to a 4-month high of 54.7. Within the detail the new orders index rose 0.6pts to 61.0 and the employment index rebounded 2.2pts to 49.8. At face value these PMI reports cast the Chinese economy in a slighted firmer light than the market had feared. That said, as usual we caution that interpreting data around the beginning of the year is complicated by the difficulty associated with accurately adjusting for regional holidays (China’s week-long Lunar New Year holiday begins on Monday).

Australia:
As usual the end of the month saw the RBA release its money and credit aggregates, in this case pertaining to December. Private sector credit rose 0.2%M/M – the smallest increase since May – so that annual growth fell 0.1ppts to 4.3%Y/Y. This marks the weakest annual growth recorded since February 2014. Housing credit rose a subdued 0.3%M/M for a fourth consecutive month, so that annual growth slowed by 0.2ppts to 5.7%Y/Y. Owner-occupier housing credit rose 0.4%M/M and 6.5%Y/Y, but investor housing credit rose just 0.1%M/M and 1.1%Y/Y. Business credit rose 0.3%M/M, lifting annual growth by 0.4pps to 4.8%Y/Y.

In other news, the ABS reported that export prices rose a stronger-than-expected 4.4%Q/Q in Q4, easily outstripping a 0.5%Q/Q rise in import prices. Compared with a year earlier export prices rose 15.7%Y/Y, whereas import prices rose just 7.8%Y/Y. Australia received sharply higher prices for exported crude materials and mineral fuels in Q4, but paid lower prices for imported mineral fuels and animal and vegetable oils.

New Zealand:
The main economic news in New Zealand today was S&P’s announcement that it had decided to move the outlook on the country’s foreign currency sovereign credit rating to ‘AA positive’ from ‘AA stable’. While Moody’s has long rated New Zealand at ‘Aaa stable’, the New Zealand dollar rose modestly on this news. New Zealand’s strong fiscal position – the outlook is for growing fiscal surpluses, further reducing an already very low level of net public debt – provides a strong foundation for the improved rating, while the slowdown in growth in housing credit and house price inflation has clearly assuaged some of S&P’s previous concerns about the much higher levels of debt held across the private sector and New Zealand’s comparatively high level of net international liabilities. Separately the RBNZ reported that growth in lending to households slowed slightly to 5.9%Y/Y in December, with growth in lending for personal consumption falling to just 2.4%Y/Y – the least since August 2016.

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