No Brexit breakthrough!

Chris Scicluna

Overview:

After Friday’s cease fire in the US-China trade war – for which details remain sketchy beyond the welcome suspension of the 5ppt hike in US tariffs on $250bn of imports of Chinese goods which had been due to kick in tomorrow – Asian stocks have started the week on the front foot. Some disappointingly weak Chinese trade data, which reported another drop in exports and a steeper fall in imports last month (see detail below), weighed somewhat on sentiment later in the day. Nevertheless, China’s CSI300 closed up a respectable 1.1%. And while Japanese markets were closed for the national holiday, the other main Asian indices rose as have US stock futures.

Japan’s national holiday meant that USTs as well as JGBs failed to trade in Asian time, after Friday’s announcement by the Fed of a new programme of T-bill purchases of $60bn per month gave support to the short end. But euro area govvies have opened higher (yields on 10Y Bunds up about 3bps to -0.48%) while euro area equities have opened lower (down roughly ½% across the board). And sterling is down about 1½ cents from Friday’s high to about $1.255 as reports suggest (unsurprisingly in our view) that the weekend’s Brexit negotiations between the EU and UK have failed to make a breakthrough not least due to Boris Johnson’s latest proposals being unworkable in current form. Brexit will continue to dominate attention in Europe both before and after the Summit on Thursday and Friday, while a busy economic dataflow this week will include GDP figures from China, inflation numbers from Japan and the UK, and reports on US retail sales and IP.

UK:

After technical-level Brexit talks over the weekend, chief EU negotiator Barnier commented that “a lot of work remains to be done”, and so negotiations will continue over coming days ahead of the summit on Thursday and Friday. Barnier’s relatively understated assessment shouldn’t have been a surprise, as Johnson’s proposals appear half-baked, most notably seemingly resurrecting Theresa May’s Customs Partnership proposals – which were previously rejected as unworkable and derided by Johnson himself and his allies – albeit limited to Northern Ireland rather than the whole of the UK.

According to this approach, while Northern Ireland would leave the EU Customs Union, the border for administrative purposes, like that for regulatory purposes under Johnson’s proposals, would run down the Irish Sea. So, the UK would agree to enforce EU customs rules and tariffs on goods moving from Great Britain to Northern Ireland. But if the EU tariff was higher than the UK tariff on the goods concerned, Northern Irish firms would subsequently receive a rebate. As well as it being impossible to believe that such arrangements could be ready to be implemented by the end of the transition period at end-2020, they would also seem to pose a high risk of fraud, thus undermining the integrity of the EU’s Single Market and Customs Union. Of course, Johnson might shift his position further over the coming couple of days to ease EU concerns. But it remains highly doubtful that a deal exists that could be agreed simultaneously by the UK Government, EU and House of Commons.

After the summit, the UK House of Commons is set to meet on Saturday to determine what to do next. If – as seems most unlikely – an agreement is reached between the EU and UK this week, UK MPs will be asked to vote on it, with the possibility that they might endorse the proposal only subject to a confirmatory referendum. If an agreement is not reached this week, however, Johnson might seek a Parliamentary vote on whether to press ahead with a no-deal Brexit. If, as we would expect, a no-deal Brexit was rejected by MPs, Johnson would then be legally compelled to write to the EU requesting an extension of the Article 50 deadline beyond end-October. Of course, this week’s summit might well offer to continue negotiations – perhaps proposing a further summit in a fortnight’s time – providing political cover to Johnson to seek the Article 50 extension that he has previously rejected.

While Brexit will rightly dominate the headlines, the coming week will also be a busy one for economic data from the UK, with several key releases. The latest labour market data are due tomorrow. While employment is likely to have slowed to its weakest rate in a year in the three months to August, the unemployment rate is expected to remain unchanged at 3.8%. Meanwhile, average labour earnings growth (excluding bonuses) seems likely to remain elevated close to the multi-year high of 4.0%3M/Y reached previously. Meanwhile, we expect the inflation numbers due the following day to report an uptick in the headline rate of CPI of 0.1ppt to 1.8%Y/Y and a similar 0.1ppt rise in the core rate to 1.6%Y/Y. Finally, the UK’s September retail sales report on Thursday is likely to show a second successive weak month with a modest decline in the headline monthly rate. However, that would still sales up over the third quarter as a whole.

Meanwhile, BoE Deputy Governor Cunliffe will speak on monetary policy later today while external MPC member Vlieghe will speak on the same topic tomorrow when Governor Carney will testify on financial stability to the House of Commons Treasury Committee. Carney might be more likely to touch on monetary policy issues when speaks at an event at Harvard’s Kennedy School on Wednesday. In the bond market, finally, the DMO will sell 10Y Gilts tomorrow.

China:

So, although the detail is still sketchy, the trade talks in Washington DC at the end of last week saw the US and China reach some kind of truce. While Trump called it a ‘substantial phase one deal’, that terminology was not shared by the Chinese authorities, and the detail seems unlikely to be pinned down until the APEC summit in mid-November. At least, the US did agree to suspend the increase in tariffs, from 25-30% on $250bn of Chinese imports, previously scheduled to go into effect tomorrow. But there was no roll-back of its tariff hikes imposed since the trade war began eighteen months ago. And the US maintained the threat of new 15% tariffs on further items (largely consumer goods) scheduled from mid-December. Moreover, the concessions from the Chinese side, which included increased purchases of much-needed US pork and soya beans, as well as vague commitments on intellectual property, exchange rate management and financial services, appeared modest suggesting that it was the US President who blinked.

Meanwhile, China’s latest trade data, reported earlier today, confirmed another decline in exports last month when new 15% US tariffs were imposed on about $112bn of Chinese shipments. In particular, exports in dollar terms fell 3.2%Y/Y. But due to slowing domestic demand as well as lower commodity prices, imports on the same basis were down 8.5%Y/Y – further bad news for the global economy – resulting in an increase of almost $5bn in the trade surplus to $39.65bn.

Looking ahead, a busy week for Chinese economic data will tomorrow bring September’s inflation data, which are likely to report an intensification of producer price deflation but a further modest increase in the CPI rate related not least to swine flu. September credit data are also due soon. Most attention, however, will likely be focused on Q3 GDP figures, which are due Friday along with the September economic activity numbers. GDP is expected to have moderated by 0.1ppt last quarter to 6.1%Y/Y, a new series low. Nevertheless, IP and retail sales are both expected to have accelerated in September, albeit representing a further moderation in growth on a year-to-date basis.

Japan:

Following today’s national holiday, BoJ Governor Kuroda’s speech tomorrow will be closely watched for further clues as to what (if anything of substance) might emerge from the monetary policy meeting at the end of the month. That speech will coincide with the publication of the BoJ’s latest quarterly Regional Economic Report (its Beige Book equivalent). Tomorrow will also bring tertiary activity data for August, which seem likely to show an acceleration of 0.5ppt to a four-month high of 0.6%M/M in response to the extra demand brought forward to dodge this month’s consumption tax hike. Final IP figures for the same month are also due tomorrow – the preliminary figures reported a drop of 1.2%M/M, which left production down a steep 4.7%Y/Y. The week’s other notable new economic data will come on Friday in the shape of the September national inflation figures – as suggested by the Tokyo numbers, the headline CPI measure (down 0.1ppt to a seven-month low of 0.2%Y/Y) and all core measures are expected to drop. In the bond market, the MoF will sell 5Y JGBs on Thursday.

Euro area:

The coming week will bring a few noteworthy euro area economic releases. First up today will be aggregate IP data for August, which are likely to show a modest increase in output, insufficient to fully reverse the 0.4%M/M decline in July and will thus leave output still down more than 2½% compared with a year earlier. These will be followed on Wednesday by final euro area CPI figures for September. Like today’s figures from Germany and Spain, headline inflation is likely to align with the preliminary readings showing a drop of 0.1ppt to 0.9%Y/Y, the lowest since November 2016. Core inflation was nudged higher in the flash estimate by 0.1ppt to 1.0%Y/Y, although rounding issues raise the risk of a downwards revision. That day will also bring new car registrations figures from the euro area, which – like the national figures for the largest member states – are likely to report a double-digit annual rate of growth at the end of Q3, flattered to some extent by the low base the previous year as new emissions testing came into effect.

Among other releases, the euro area’s trade report (Wednesday) is likely to show a narrowing in the surplus in August on the back of subdued external demand, and will be followed by the latest balance of payments figures (Friday). At the country level, final French and Italian CPI numbers are due Tuesday and Wednesday respectively, while Germany’s ZEW sentiment survey for October is due Tuesday.

Elsewhere, various ECB Governing Council members will speak at the IMF Annual Meetings in the coming week, including Chief Economist Lane, as well as Knot, Weidmann, and Villeroy (all opposed to the latest round of QE). In the markets, Germany will sell 2Y bonds on Tuesday and 20Y bonds on Wednesday, while France and Spain will issue bonds with various maturities on Thursday.

US:

In the US, it should be a quiet start to the coming week for economic releases with markets closed today for a national holiday and just the Empire Manufacturing index for October out tomorrow. Wednesday’s release of September retail sales figures will provide an insight into household consumption in the third quarter. That day will also bring business inventories numbers for August, the Fed’s latest beige book and the NAHB housing market index for October. These will be followed on Thursday by industrial production numbers for September, which are expected to show renewed manufacturing weakness at the end of the quarter, albeit not fully reversing the increase in August. That day will also bring September housing starts data, October’s Philly Fed index and weekly claims figures, followed on Friday by the Conference Board’s latest leading indicators.

In terms of Fed Speak, a number of voting FOMC members will be in action in the coming week including Bullard and George (tomorrow), Evans and Brainard (Wednesday), Evans, Bowman and Williams (Thursday) and Clarida (Friday). In the markets, the Treasury will sell 5Y TIPS on Thursday. And, from tomorrow the New York Fed will undertake its new programme of T-bill purchases, at a rate of $60bn per month, aimed at maintaining over time ample reserve balances and hence avoiding the pressures in funding markets that emerged towards the back end of last quarter.

Australia:

Notable information with respect to the outlook for RBA policy will come tomorrow in the shape of the minutes of this month’s policy meeting, when the Cash Rate was cut by a further 25bps to 0.75%. In addition, with developments in the labour market being judged key for the inflation outlook, Thursday’s jobs data will be particularly closely watched. Employment growth is likely to have slowed in September below the 26k average for the year-to-date while the unemployment rate is expected to have remained unchanged at 5.3%, some way above the RBA’s estimate of the NAIRU.

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