Morning comment: Post-Commons Pre-Fed data deluge

Chris Scicluna
Mantas Vanagas

Despite some downward pressure on tech stocks – the Nasdaq fell 0.8% – the S&P500 closed with only a modest 0.15% loss on Tuesday, with investors seemingly awaiting direction from today’s FOMC meeting and the two-day trade meeting between US and Chinese officials which also begins today. In the bond market US Treasury yields slipped 2-3bps, however, as the Conference Board reported a decline in consumer confidence to its lowest level since June 2017. Credit spreads were little changed, as was the US dollar.

After the Wall Street close Apple Inc. stock rallied more than 5% in extended trading after the company’s quarterly earnings report and commentary appeared to better the market’s lowered expectation (the latter in the wake of the downgraded guidance issued last month). As a result, Asian equity markets have generally performed a little better than might have been expected based on the performance of technology stocks during normal US market hours. For the most part the key regional bourses have closed with gains or losses of no more than +/-0.2%. Japan’s TOPIX was one to close modestly in the red, but JGB yields were little changed while the latest retail sales data beat expectations but consumer confidence deteriorated (detail below).

In the euro area, government bonds have opened a touch higher despite upside surprises to both French GDP and German consumer confidence, which were the first releases to see the light of day on a busy day for new data from the region. Meanwhile, gilts are little changed while sterling remains down almost 1 cent against the dollar from its level this time yesterday after taking that step down in the midst of yesterday evening’s House of Commons votes. But those votes have changed little in the grand scheme of Brexit, with Theresa May given a fortnight to try to negotiate alternative arrangements for the Irish border – something the EU unsurprisingly remains unwilling to countenance – before MPs will come back to vote once again.

Finally, of course, the main events today will come in the US, where trade negotiations with the Chinese will restart and the latest Fed policy meeting will conclude with a press conference from Chairman Powell.

The domestic data-flow in Japan today was focused on the household sector. First up, METI reported that the value of retail sales had increased a stronger-than-expected 0.9%M/M in December, largely erasing a 1.1%M/M decline in November. Annual growth in sales eased 0.1ppt to 1.3%Y/Y, nonetheless. Increased spending on household machines and apparel contributed to the rebound in sales in December, which also means that the value of retail sales rose a solid 1.1%Q/Q in Q4. Last week the Cabinet Office reported that the synthetic consumption index – the most reliable indicator of the national accounts based measure of private consumption – was tracking 0.8% above its Q3 average during the October/November period. Combined with today’s figures, private consumption appears to be well on track to contribute to a rebound in GDP in Q4 following the very disappointing contraction recorded in Q3.

In other news, the Cabinet Office released the results of its survey of consumer sentiment for January. The headline index fell for the fourth consecutive month, declining 0.8pts to 41.9. This marks the lowest reading since November 2016 and leaves the index only slightly above its long-term average. Within the detail declines were recorded across all of the main sub-indices. The biggest decline was in the employment index, which fell 1.5pts to 44.3, while the index measuring consumers’ willingness to buy durable goods fell 1.1pts to 41.7 (in both cases also the lowest readings since November 2016). In recent times Japan’s consumer spending has been constrained more by income growth than any lack of optimism by consumers, but weakening consumer sentiment remains an unwelcome development nonetheless. 

Euro area:
Today’s euro area economic data flow kicked off with a couple of rare upside surprises, starting with the first estimate of French GDP in Q4. The figures showed an increase of 0.3%Q/Q, unchanged from Q3 and 0.1ppt above the market consensus and the rate of growth foreseen by the Bank of France. However, that left the annual growth rate down 0.4ppt from Q3 at only 0.9%Y/Y, which represents a sharp slowdown from 2.8%Y/Y a year earlier. Perhaps surprisingly given the downbeat mood around global demand, net trade was the main driver of growth in Q4 on a Q/Q basis, contributing 0.2ppt, as the rise in exports of 2.4%Q/Q beat the 1.6%Q/Q growth rate of imports. But domestic demand growth was unimpressive. With consumer confidence having deteriorated sharply amid widespread demonstrations at the end of the year, the level of household consumption was unchanged, having risen 0.4%Q/Q in Q3. Investment was up 0.2%Q/Q, with weakness in the private sector offset by stronger growth in government capex.

Looking ahead, such firm export growth seems unlikely to be maintained. And despite a moderate improvement in consumer sentiment in January against the backdrop of President Macron’s fiscal policy U-turn, we do not expect a vigorous rebound in household consumption this quarter. Against this backdrop, we think that French GDP will grow by 0.3%Q/Q again in Q1, and perhaps in the coming few quarters too to result in full-year growth of just 1.0%Y/Y in 2019.

Meanwhile, this morning’s German consumer confidence survey was also slightly stronger than expected, with the headline index rising from 10.5 to 10.8, a level previously seen last May. German consumers were more upbeat about their incomes, and their willingness to buy also improved – both appear to be a result of ongoing improvements in the labour market, with ongoing jobs growth and the strongest growth in wages for decades. In contrast, however, consumers’ assessment of the economy deteriorated for a fourth month in a row to the weakest level since early 2017. The survey suggested that consumers remain concerned about a number of external economic factors – from the US/China trade war to Brexit – but the strength of the jobs market should continue to provide a decent level of comfort going forward.

Later today we’ll receive the first guide to inflation this month in the form of the flash German CPI data. With prices expected to have declined sharply in January (-1.0%M/M), the annual rate of inflation is expected to be unchanged at 1.7%Y/Y. Also due this morning are the results of the European Commission’s business and consumer surveys – arguably the best guide to euro area GDP growth. While the flash consumer indicator suggested a modest improvement in January (albeit at -7.9 it was still the second-lowest reading in twenty-two months), business sentiment is expected to have further deteriorated at the start of the year. So, the headline Economic Sentiment Indicator is forecast to record the thirteenth consecutive decline to its lowest level since November 2016.

In the markets, Germany will sell 10Y Bunds, while Italy will sell bonds with various maturities.

Despite the political theatrics, there were no major game-changers from yesterday evening’s seven Brexit votes in the House of Commons. May lives to fight (and negotiate) another day. All key Brexit scenarios remain feasible, including an eventual deal, an Article 50 extension, or a no-deal Brexit. And MPs will have to come back in a fortnight's time to take stock and vote all over again.

In particular, as a sufficient number of Conservative and DUP MPs united with a number of Labour rebels to back an amendment tabled by Tory MP Sir Graham Brady, May received a notional mandate from a majority of MPs (by 16 votes) to attempt a renegotiation of the Brexit deal which she herself reached with the EU late last year but was rejected earlier this month. Specifically, the PM will seek legally binding ‘alternative arrangements’ to avoid a hard border in Ireland in place of the existing ‘backstop’ before returning for a further Parliamentary statement and votes on the way forward on 13-14 February.

At face value, that vote on the Brady amendment would imply that a majority of MPs exists for a form of Brexit that is not a million miles from the deal that May negotiated last year. But May failed to give an indication as to what precise ‘alternative arrangements’ she might actually propose to the EU27. And crucially, that form of Brexit might well prove undeliverable. The EU has long made clear that it has no intention to renegotiate or agree to any alternative to the backstop, or indeed anything else in the Withdrawal Agreement, and a spokesperson for EU President Tusk reiterated that shortly after the vote.

Tusk’s spokesperson did, however, repeat that the EU would be prepared to revisit the Political Declaration on the future relationship (i.e. on matters related to the customs union and single market), and also stated that – should the UK request it – the EU would stand ready to consider an extension of the article 50 deadline (albeit ‘taking into account the reasons for and duration of [it]). Admittedly, in other votes, MPs rejected amendments last night that would have demanded that May seek an extension of the Article 50 deadline if no agreement had been endorsed by late February, or would have allowed MPs to take control of the Parliamentary agenda to steer Brexit policy more actively. But MPs did back a (non-binding) amendment to reject the notion that the UK might leave the EU without a deal. And should May fail to secure significant concessions from the EU on the backstop over the coming couple of weeks, the majority in favour of that amendment might, on 14 February, crystallise in favour of demanding an extension to the Article 50 deadline and also taking new action to take greater control from the Government of the Brexit process.

So, where does this leave us? Our base-case scenario remains that the Article 50 deadline will be extended to avoid a no-deal Brexit on 29 March. But whether that proves to be a short-term technical extension (say of three months) to facilitate the adoption of legislation to implement a version of May’s deal (on balance, probably just about most likely, albeit probably not with substantive changes to the backstop but instead with a fig-leaf offered by Brussels to protect May’s modesty and retain the support of those who voted for the Brady amendment), or a longer-lasting extension (say of nine months) to facilitate consideration of alternative ways forward, remains to be seen.

As the dust settles after yesterday evening’s Parliamentary votes, the UK’s economic data will, of course, remain of secondary importance. Nevertheless, the BoE will announce its latest lending indicators, which are likely to confirm that mortgage approvals for house purchase declined again in December as housing market sentiment deteriorated towards the end of the last year.

In the US, as the next phase of US-China trade talks get underway in Washington DC, the main focus will be the conclusion of the FOMC’s latest two-day meeting, accompanied by Chair Powell’s post-meeting press conference. While there will be no change to policy, and there will also be no updated economic forecasts published this time around, Powell will likely adopt a more dovish tone than in December recognising heightened economic uncertainties around the turn of the year, including the impact of disruption from the government shutdown. Powell might also use his press conference to provide new information on the Fed’s plans on balance sheet normalization. Data-wise, ahead of Friday’s payrolls figure, the ADP employment report will be closely watched, while pending home sales figures for December are also due.

The main domestic focus today was on the release of the CPI report for Q4. The headline index rose 0.5%Q/Q – 0.1ppts above market expectations but nonetheless still causing annual inflation to decline by 0.1ppts to 1.8%Y/Y. Key upward contributions were made by tobacco (up 9.4%Q/Q due to a rise in excise tax), domestic holiday travel and accommodation (up 6.2%Q/Q) and fruit (up 5.0%Q/Q). The largest price declines were for AV and computer equipment (down 3.3%Q/Q) and automotive fuel (down 2.5%Q/Q). Non-tradeables prices rose 0.9%Q/Q, raising annual inflation for this indicator of domestic inflation by 0.2ppts to 2.4%Y/Y. Tradeables prices fell 0.3%Q/Q and were up just 0.6%Y/Y. More importantly for monetary policy, both of the RBA’s favoured statistical measures of core inflation – the trimmed mean and weighted median – remained inconsistent with inflation moving back inside the RBA’s 2-3% target band. The weighted median rose a less-than-expected 0.4%Q/Q. While this was a 0.1ppts less than market expectations, an offsetting upward revision to Q3 meant that annual growth in this measure met market expectations at 1.7%Y/Y. The trimmed mean also rose 0.4%Q/Q in Q4 – in line with market expectations – leaving annual inflation on this measure steady at 1.8%Y/Y.

Market reaction to the CPI report suggests that investors were positioned for the possibility of a repeat of the big downside surprise experienced in Q3. So while on balance the key measures of underlying inflation were broadly in line with surveyed market expectations – and the average of the RBA’s favoured statistical measures accorded with the year-end 1¾%Y/Y forecast made by the RBA in November – interest rate markets sold off modestly (bond yields rising about 2bps) and the Australian dollar firmed following the release of the CPI report. Given the general performance of the economy we think that today’s outcome remains consistent with the RBA’s stance that the likely next move in policy will be a tightening, rather than the easing that the market has been mulling of late. At the same time, today’s outcome also supports the RBA’s view that there is no strong case for a near-term tightening of policy. Indeed, the RBA’s November forecasts had already implied that policy tightening was most likely to begin in 2020, rather than in 2019.

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