US stocks posted modest losses yesterday, with the S&P500 closing down 0.3%. But USTs made gains (10Y yields falling about 4bps to around 2.38%) seemingly pulled higher by Gilts (10Y yields down almost 7bps to 1.01%) as it became patently clear that Theresa May’s time as UK Prime Minister is all but finished. Markets were little affected by the Fed’s latest policy meeting minutes, which nevertheless had a relatively dovish tone, underscoring the need for “a patient approach” to policy “even if global economic and financial conditions continued to improve”.
Against that backdrop, and with the negative tone around the trade war compounded by reports that Chinese surveillance firm Hikvision may soon be blacklisted by the Trump administration, the major Asian-Pacific equity indices have been in the red today, e.g. with China’s CSI300 down 1.5%. While the yen was steady, the mood in Japan wasn’t helped by a downbeat manufacturing survey (detail below), although the Topix closed down a relatively modest 0.4%. And despite yesterday’s shifts in other major government debt markets – which were followed today by ACGBs, whose 10Y yields were down 5bps to a new low of 1.58% – JGBs were only slightly firmer.
European government bonds (except BTPs) have opened higher this morning too, with the mood around equities unfavourable too while sterling has taken another step down to close to $1.260. But, looking ahead, a busy dataflow from the euro area will bring the May flash PMIs, which – like this morning’s French INSEE business survey – are expected to point to improved business conditions in Q2. While the latest ECB policy meeting account is also due, there will be precious little further news today on Theresa May’s political future as the UK goes to the polls to vote in the European Parliament elections.
Theresa May’s Brexit plans looks dead in the water, and her demise as Prime Minister is assured. Plenty of questions remain, however, including precisely when she’ll confirm her resignation as party leader – quite possibly tomorrow when she is set to meet Sir Graham Brady, chair of the key backbench 1922 Committee which sets the Conservatives’ leadership rules. What that will mean for her precise date of departure from Downing Street however is also uncertain – May will want to hold out for at least six more days to overtake Gordon Brown’s tenure as PM, while Parliament is now in recess until 4 July.
The matter of who will take over from May will remain unclear for some time longer still. In what could become a lengthy leadership contest, advocates of a no-deal Brexit – former Foreign Secretary Boris Johnson and former Brexit Secretary Dominic Raab – are by some margin the bookmakers’ favourites, reflecting the bewildering popularity of that damaging policy stance and their peculiar (arguably downright unsavoury) personalities with the Tory rank-and-file. But, with a chance that the MPs will be able to resolve the matter for themselves without having to go to a ballot of the party members, the somewhat more balanced Environment Secretary Michael Gove looks a decent bet to us, particularly given best current odds of 12/1. Whoever eventually takes over, however, will find it no easier to resolve the Brexit deadlock, not least since they will not be able to change the parliamentary arithmetic without a general election.
There should be no substantive political news from the UK today, however, due to the media purdah as voters go to the polls in the European Parliament (EP) elections. As elsewhere in the EU, no results will be available before Sunday night, when the humiliation of the Conservatives will be laid bare. Opinion polls suggest the party is on track for its worst performance ever, perhaps ending behind the Greens in fifth place with less than 10% of the vote. And that could mean it would lose all bar one of its current tally of 18 EP seats, out of a total of 73 held by the UK. Nigel Farage’s Brexit party – which, with the exception of advocating a no-deal Brexit, shares the Tories’ policy vacuum – is set to take the largest share of the vote, perhaps with more than 30%. So, its performance will likely better that of Farage’s former UKIP party which topped the poll at the previous EP election in 2014. Meanwhile, the pro-remain Lib-Dems appear on track to beat Labour to second place, to provide a damning public verdict on the main opposition party’s fence-sitting Brexit policy.
Beyond all the politics, in the bond market, the DMO will sell 10Y inflation-linked Gilts.
While yesterday’s Reuters Tankan survey was a little more upbeat than of late about business conditions in the middle of the second quarter, today’s flash manufacturing PMIs disappointed. In particular, the headline index fell 0.6pt to 49.6, back in contractionary territory for the third month out of the past four, while the output component fell 0.4pt to 48.4, the fifth consecutive sub-50 reading. Despite a modest pickup in the new orders index, it too continued to signal contraction for the fifth month, with the new exports orders PMI recording the second-lowest reading for almost two years. And the survey suggested that manufacturers were their most downbeat about expectations for the coming year for 6½ years. So, while we expect manufacturing output to return to expansion after the steep decline in Q1, today’s survey was another reminder that output growth in the sector is likely to be at-best moderate rather than vigorous. The news from the survey regarding inflation was also disappointing, with the output price PMI declining 1pt in May to 50.9, a twenty-month low.
Data-wise, today brings the most notable euro area economic data of the week with the May results of several top-tier business surveys, including the flash PMIs as well as the German ifo indices. In April, the euro area composite PMI fell 0.3pt to 51.3, below the Q1 average, to suggest a slight loss of momentum at the start of Q2. The euro area services PMI fell 0.8pt to 52.5 while the manufacturing PMI rose 0.4pt but remained very weak at 47.9. However, we expect to see some improvement in today’s surveys.
Indeed, with respect to the national releases, we have already seen a decent showing from the French INSEE survey, which saw the headline index come in at 106 in May, unchanged from an upwardly revised reading in April, which was the highest since last July. This reflected a notable improvement in manufacturing confidence, with the relevant index rising 3pts to 104, a six-month high. In contrast, however, confidence in the services and retail sectors slipped back slightly, albeit the respective indices remained comfortably above the long-run average.
Separately, the final estimate of German GDP in Q1, also released this morning, brought no major surprises, with the figures confirming that the economy returned to growth in the first quarter, at a surprisingly firm 0.4%Q/Q. The main focus was on the first release of the expenditure breakdown, which showed that growth was principally underpinned by domestic demand. In particular, household consumption growth accelerated to 1.2%Q/Q in Q1, the strongest increase since 2011, to more than fully account for GDP growth. In addition, private sector capex was stronger across the board in Q1, with machinery and equipment investment up 1.2%Q/Q, while construction investment rose 1.9%Q/Q, the firmest rate for two years. But after a strong increase at the end of last year, government consumption fell in Q1. Furthermore, for a second quarter, there was another notable drag on growth from stocks in Q1, subtracting 0.6ppt from growth. Encouragingly, exports posted their strongest rise for five quarters (1.0%Q/Q), while imports were up 0.7%Q/Q. So, net trade made the first positive contribution to German GDP growth since 2017.
For an assessment of yesterday’s Fed minutes, please see the note from Daiwa America Chief Economist Mike Moran here. Looking ahead, today will bring new US home sales data for April, the preliminary Markit PMIs and Kansas City Fed manufacturing indices for May, and the usual weekly claims figures. In the bond market, the Treasury will sell 10Y TIPS.