Oil and the Fed to dominate the week ahead

Chris Scicluna
Emily Nicol

Following the weekend’s strike on a key Saudi oil facility, which caused the suspension of more than 5mn barrels of crude a day (or about 5% of global oil supply), Brent futures jumped almost $12 (almost 20%) to close to $72bbl at the open, before settling down to a little more than $66bbl (up a little more than 10% from Friday’s close). President Trump tweeted before market opening that he had authorized the release of oil from the Strategic Petroleum Reserve “if needed” but subsequently added that the US was also “locked and loaded”, thus threatening a military response. He nevertheless also added cryptically, “PLENTY OF OIL!”. Of course, if sustained, the higher oil price will provide very much the wrong type of inflationary impulse to the global economy, acting to weigh on global consumer spending and – with the exception of the energy industry – business investment.

Markets also had some further Chinese economic data to digest today, and these disappointed expectations across the board once again (see below) suggesting that policy stimulus had yet to bear fruit. Nevertheless, while Japan’s markets were closed for a national holiday, and US and European futures are pointing lower, the region’s other main indices saw a mix of gains and losses, e.g. while China’s Shanghai composite closed little changed and the Hang Seng is down more than 1.0%, Korea’s Kospi index rose 0.6% to the highest close since late July. Following last week’s sharp adjustment in global bond markets, which culminated on Friday with a near-12bps rise in 10Y UST yields to close to 1.90%, most sovereigns in the Asia-Pacific region have moved lower again today (e.g. yields on 10Y ACGBs rose 3bps to close to 1.19%).

Looking ahead, ECB Chief Economist Lane and Board member hawk Lautenschlaeger will speak publicly today. And ahead of a hearing at the UK Supreme Court into his decision to shut down Parliament, UK PM Johnson will meet with Commission President Juncker to discuss Brexit (and both will no doubt emphasise their desire to get a deal to allow the UK to leave the EU at end-October, without giving any meaningful indication of what that deal would look like). Of course, key events this week include the latest policy announcements from the Fed (a 25bp cut in the FFR is fully priced in, but what will be signalled for thereafter is highly uncertain) and the BoJ (expect no substantive change to policy on Thursday). The BoE’s policy meeting should be a relative non-event.

The main event in Japan this week will be the conclusion of the BoJ’s latest Policy Board meeting on Thursday. The outcome of this meeting is more uncertain than other policy-setting meetings this week. At face value, the economic backdrop – with recent releases on the whole pointing to softer economic momentum and weaker inflation – would appear to have strengthened the case for additional easing. But while BoJ Governor Kuroda recently noted in a Nikkei newspaper interview that "We're considering a variety of possibilities, including combinations of [measures] and improved versions", it remains doubtful that the Bank will feel inclined to pull the trigger on new stimulus just yet. Certainly, there would be great reluctance to cut the policy rate from the current -0.10% level for concerns the so-called reversal rate has been reached. And the past week’s moves in financial markets – with 10Y JGB yields having returned to within the BoJ’s informal target range (+/-0.20%) and the yen depreciating back through ¥108/$ - would also allow it a little more time to sit tight as far as yield curve control is concerned.

Reports on Friday suggested that BoJ officials favour setting a floor to the 10Y JGB yield around -0.30%, with any sustained shift or surge below that level prompting consideration of further action However, any action this week might only be limited to a mere amendment of the Policy Board’s forward guidance, which currently states that “the Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020”. Of course, if and when demand weakens following next month’s consumption tax hike, substantive easing might well prove harder to resist.

Data-wise, Wednesday’s trade report will be closely watched for the latest insights into Japanese exports in the middle of Q3 – the twenty-day figures suggest a notable deterioration in the year-on-year rate of growth to a decline of more than 11%Y/Y. That day will also bring the latest overseas visitor figures for August. The end of the week will conclude with the latest national CPI figures for August on Friday, which seem likely to post a further decline in the headline and BoJ forecast measures – with the latter expected to fall 0.1ppt to just 0.5%Y/Y, which would be a more-than two-year low. Friday will also bring revised wage figures for July, as well as the BoJ’s latest flow of funds figures for Q2. In the markets, the MoF will sell 20Y JGBs on Wednesday.

Of course, all eyes in the coming week will be on the Fed’s latest policy announcement on Wednesday. While the target range for the Fed Funds Rate is widely expected to be lowered by 25bps to 1.75-2.00%, the Fed’s policy statement, updated economic forecasts and dot-plot charts, as well as Chair Powell’s post-meeting press conference will be closely watched for insight into the near-term policy path.

Data-wise, the US highlight will likely be tomorrow’s release of industrial production figures for August, which are expected to show total output reverse the 0.2%M/M drop seen in July, with similarly modest growth in manufacturing despite a steeper decline in the previous month. Ahead of this the Empire Manufacturing index for September will come today. Meanwhile, the Philly Fed index and Conference Board’s leading indices and balance of payments data are due on Thursday. And housing market figures due in the coming week include the NAHB housing index (tomorrow), housing starts (Wednesday) and existing home sales (Thursday). In the markets, the Treasury will sell 10Y TIPS on Thursday.

Euro area:
Politics-wise, the coming week will be key in Spain, where the King will today and tomorrow hold talks with the respective party leaders to see whether majority support can be found for one of them to form a new government. Since April’s elections saw the Socialist Party (PSOE) of Prime Minister Pedro Sánchez comfortably win by far the largest share of the vote (29%) but fall short of a majority, he has been unable to form a new government with the backing of Parliament. To avoid a fourth general election in four years, Sánchez has until one week today to be able to establish a new administration. But if he tells the King tomorrow that he is unable to form a new government – which would require doing a deal with the populist left-wing Podemos – then the Spanish public will return to the polls on 10 November.

After last week’s excitement at the ECB, this week will bring the first of the new TLTRO-III operations, where banks will benefit from more generous conditions than previously thought (an interest rate as low as the deposit rate if they increase lending sufficiently, and a maturity of up to three years). The coming week should be relatively quiet for euro area economic data, with the Commission’s flash September consumer confidence index on Friday arguably the data highlight. The headline indicator has effectively trended sideways over the past six months. And while it fell a larger-than-expected 0.5pt in August to -7.1, that left it still broadly in line with the average since the start of the year.

Meanwhile, Wednesday’s release of final euro area CPI data for August seems set to confirm very subdued price pressures, with headline inflation expected to align with the preliminary reading of 1.0%Y/Y, unchanged from July’s 2½-year low. While core CPI was also unchanged at 0.9%Y/Y in the flash estimate, due to rounding there is a risk this will be nudged slightly higher. Wednesday will also bring new car registrations figures for August and construction output data for July, followed on Thursday by the latest current account report for July. At the country level, final Italian CPI figures for August are due today, while tomorrow will bring Germany’s ZEW survey of analysts for September. In the markets, Germany will sell super long-dated bonds on Wednesday, while France and Spain will sell bonds with varying maturities on Thursday.

Politics will remain front and centre in the UK, with PM Boris Johnson travelling this morning to Luxembourg for Brexit talks with European Commission President Jean-Claude Juncker. However, with the UK Government having yet to table any substantive proposals at official level, it seems inconceivable that anything meaningful will emerge from today’s talks. Expect both sides to emphasise that they want a deal to allow the UK to leave the EU at end-October, but also to acknowledge that the timetable is tight. And while there will no doubt be a willingness to explore a legally enforceable substitute for Theresa May’s UK-wide backstop, quite what that might look like will likely remain shrouded in mystery at least until the Conservative party conference at the turn of the month is out of the way.

Meanwhile, tomorrow will see a UK Supreme Court hearing begin on whether Johnson’s suspension of Parliament was unlawful – a judgement is perhaps most likely to come on Thursday. Should it rule in favour of the complainants, the UK’s political crisis will have become a constitutional one. But even if it also prompts a chorus of calls for Johnson’s resignation for misleading the Queen, and the recall of MPs back to Parliament, the outcome seems unlikely to change the near-term Brexit outlook – Johnson will still be required by law to request an Article 50 extension should a new deal not be agreed with EU leaders by 19 October. Indeed, a separate legal action to be heard in a Scottish court could compel a court clerk to write to the EU to request the Article 50 extension on 19 October if PM Johnson refused to do so.

The coming week will bring a number of key events on the UK economic front, including the BoE’s latest monetary policy decision on Thursday, although Bank Rate is widely expected to be left unchanged at 0.75%. While GDP in Q2 was weaker than the BoE’s expectation, last week’s monthly GDP figures for July were firmer and seemed to rule out the chances of another contraction in Q3. And with wage growth having risen to the highest rate in eleven years, we would expect no change to the MPC’s forward guidance that “assuming a smooth Brexit and some recovery in global growth…the Committee judges that increases in interest rates, at a gradual pace and to a limited extent, would be appropriate”. That said, Carney will no doubt acknowledge that a smooth Brexit can hardly be taken for granted.

With respect to economic data, Wednesday’s CPI release will be closely watched, with the headline rate expected to fall in August by 0.3ppt to 1.8%Y/Y, principally on the back of lower energy prices. But core inflation is also expected to edge lower, by 0.1ppt to 1.8%Y/Y. The following day will bring retail sales figures for August, which, in line with recent downbeat surveys, are expected to report a decline in spending for the first month in three.

While recent surveys suggested that conditions in the Chinese economy were little changed in August, today’s activity and spending figures for that month disappointed expectations across the board, illustrating the negative impact of the ongoing US-China trade war on the manufacturing sector and the likely need for more policy support over the near term. In particular, industrial production growth slowed again in August, by 0.4ppt to just 4.4%Y/Y, the weakest rate since early-2002, with manufacturing growth 0.2ppt lower at 4.3%Y/Y despite a notable improvement in autos production. Fixed investment figures were also softer in August, with the year-to-date increase easing slightly to 5.5%YTD/Y, with weakness dominated by the private sector (growth of 4.9%YTD/Y was the weakest since 2016), with services growth (2.1%YTD/Y) the second-lowest since 1999. But retail sales figures for August suggested that domestic demand remained subdued too, with growth moderating to 7.5%Y/Y, the second-lowest reading since mid-2003. And growth was principally supported by spending on food (12½%Y/Y), while sales of autos fell more 8%Y/Y.

The main economic focus in Australia this week will be Thursday’s labour market report, which is expected to show a further modest increase in employment in August to leave the unemployment rate unchanged at 5.2% for the fifth consecutive month, still considerably higher than the RBA’s central estimate of the equilibrium rate (4½%).

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