All eyes on the Fed

Emily Nicol

Overview:
After a particularly weak performance in European markets yesterday, and US bourses ended the day lower, Asian equities started the day on the back foot. And with surveys – including the Chinese PMIs and Japanese consumer confidence – suggesting continued subdued economic growth at the start of Q3, and no signal as to how the China-US trade discussions progressed today, equities failed to gain ground through the day. As such, China’s main CSI 300 and Japan’s Topix closed the day 0.9% lower. And as Hong Kong’s markets closed early as a heavy tropical storm approached, the Hang Seng was down 1.3% on the day.

The Aussie dollar received a modest boost after Australia’s inflation came in a touch above expectations. But with underlying price pressures still subdued, yields on 10Y ACGBs fell 2bps to a new low of 1.18%. Yields on euro area government bonds were also a touch lower this morning, ahead of today’s flash estimates of euro area Q2 GDP and July inflation. But, of course, most attention today will be on the Fed’s policy announcement this evening.

Japan:
While the BoJ yesterday maintained a broadly upbeat message about the near-term growth outlook with Japan’s domestic demand expected to maintain an upward trend, the latest monthly consumer confidence survey was hardly encouraging about conditions in the household sector at the start of Q3. In particular, the headline sentiment index declined for the tenth consecutive month in July and by 0.9pt to 37.8, its weakest level since the previous consumption tax hike in April 2014. While the weakness was again widespread, there was another notable deterioration in households’ willingness to buy durable goods, with the relevant index falling 2.2pts to its lowest reading since the previous consumption tax hike in April 2014, suggesting that underlying consumption growth will remain subdued over coming months.

China:
The overnight release of the Chinese government’s official PMIs for July provided mixed messages. On the positive side, there was an improvement in the headline manufacturing index, up 0.3pt to 49.7, a three-month high albeit still in contractionary territory. The manufacturing output component also increased for the first month in four, by 0.8pt to 52.1. And perhaps surprisingly given ongoing uncertainties with the China-US trade dispute, the new export orders PMI edged slightly higher in July, although at 46.9 it still pointed to significant declines. But the pickup in the manufacturing PMI was underpinned by improved conditions at larger firms, with the respective index up 0.8pt to 50.7. In contrast, the headline PMIs for medium and small-sized firms slipped further into contractionary territory in July.

The non-manufacturing survey was also more downbeat, with the headline PMI declining for the third month out of the past four to 53.7, an eight-month low. And there was a steeper drop in the survey’s new orders component to just 50.4. So, while the composite PMI edged slightly higher in July, up 0.1pt to 53.1, this still remained below the average seen in Q2 and consistent with a more subdued pace of economic growth at the start of Q3.

Euro area:
After the Commission’s economic survey yesterday signalled a further moderation in economic momentum at the start of the third quarter, a key economic focus in the euro area today will be the first estimate of Q2 GDP, which will provide confirmation of the extent to which output slowed last quarter. In particular, euro area growth is expected to have moderated to just 0.2%Q/Q, half the pace of Q1. This would leave the year-on-year rate of increase at just 1.0%, the softest pace since Q413. This morning will also bring preliminary GDP figures from Italy, with non-negligible risks that growth will have returned to negative territory. But while growth moderated in Q2, this morning's figures showed that Spain’s economy expanded by a still-healthy 0.5%Q/Q, down 0.2ppt from Q1.

Today will also bring the flash estimates of July CPI from the euro area, France and Italy. Having surprised to the upside in June, euro area headline and core CPI are expected to have edged lower in July by 0.1ppt to 1.1%Y/Y and 1.0%Y/Y respectively. Of course, given the significant downside surprise to yesterday’s German data – with the headline EU-harominsed CPI rate down 0.4ppt to just 1.1%Y/Y, the lowest since September 2016 – we might well see a larger drop in the euro area figures. This notwithstanding, French inflation figures just released were broadly as expected, with the EU-harmonised rate down 0.1ppt to 1.3%Y/Y.

Wednesday will also bring euro area unemployment figures for June, as well as Germany’s labour market data for July. This morning also brought German retail sales figures for June, which surprised significantly on the upside, with sales up a whopping 3.5% on the month, the most since 2006! But this followed notable weakness in May and left sales down 1.6%Y/Y. Moreover, sales were up just 0.1% over the second quarter as a whole, a marked slowdown from the 1.7%Q/Q increase seen in Q1 and consistent with our view that German GDP growth slowed notably in Q2 from 0.4%Q/Q. And given the likely contraction in the manufacturing sector, there is still non-negligible risk of negative growth.

UK:
While the appointment of Boris Johnson as Prime Minister has prompted increased concerns, among businesses and financial markets alike, about the prospects of a no-deal Brexit, there was a somewhat surprising improvement in consumer confidence this month. In particular, the headline sentiment index rose 2pts to -11, with households reportedly more optimistic about their personal finances and therefore a greater share assessing it to be an appropriate time to make major purchases – indeed, the survey’s purchase index rose 6pts to +4, a five-month high. Of course, consumer confidence still remains well below the levels seen before the 2016 referendum. And today’s figures are hardly indicative of an acceleration in household spending over coming months.

US:
The main event today will of course by the FOMC announcement, where ere a cut of 25bps is widely expected, taking the FFR target range to 2.00-2.25%. While some recent US data have surprised to the upside, we expect the policy statement and Chair Powell to adopt a broadly dovish tone, highlighting underscoring the downside risks to the outlook from abroad and concerns that US inflation will remain below target for far longer than originally anticipated, and therefore leaving the door open for further cuts this year. With respect to data, today will bring the employment cost index for Q2, along with the ADP employment report for July.

Australia:
Ahead of next week’s RBA policy-setting meeting, the main focus in Australia overnight was the Q2 inflation release. And the headline CPI figure came in a touch stronger than expected, rising 0.7%Q/Q – the largest quarterly increase for four years – to leave the annual pace of CPI up 0.3ppt to 1.6%Y/Y. But the pickup principally reflected higher petrol prices (up 10.2%Q/Q), while recreational services inflation was boosted by holiday-related price increases (2.7%Q/Q). And despite this improvement, headline CPI still fell short of the RBA’s expectations of an increase of 1.75%Y/Y in Q2. Moreover, the RBA’s preferred statistical measures of core inflation – the trimmed mean (unchanged at 1.6%Y/Y) and weighted median (unchanged at just 1.2%Y/Y) – remained very subdued and inconsistent with inflation moving back inside the RBA’s 2-3% target band. So, while the RBA is expected to keep its main policy rate on hold at 1.00% next week, the accompanying policy statement and updated forecasts are likely to keep the door open for further policy easing over coming quarters.

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