Risk appetite continues to wane

Emily Nicol
Chris Scicluna

Overview:
With the coronavirus continuing to spread and its death toll rising further, the Chinese national authorities have extended the Lunar New Year holiday nationwide by three days to 2 February and some local authorities have gone beyond that (e.g. Shanghai has reportedly suggested that companies should not restart work until at least 9 February). And so the economic costs of the outbreak appear to be mounting. Inevitably therefore, with no new economic data released to provide distraction, those Asian financial markets that were open today were characterised by heightened risk aversion, and that trend has been extended to Europe this morning.

So, for example, in forex markets, the offshore Chinese yuan depreciated through 6.97/$ for the first time since the first week of January, while the yen appreciated back to around 109/$ for the first time since 8 January. Where they were trading, stocks fell sharply, e.g. the Nikkei 225 closed down 2.0% on the day while Chinese stock futures plummeted. And in the bond markets, the inevitable flight to quality saw USTs rally across the curve, with 10Y yields down more than 10bps from this time Friday to below 1.65% for the first time since early October, and futures suggesting a greater likelihood of a Fed rate cut around mid-year. JGBs were also stronger, with 10Y yields down about 2.5bps to -0.05%.

Euro area govvies also predictably opened stronger this morning. Most notable in this respect, however, were BTPs, whose 10Y yields have dropped more than 17bps at the open, to push the spread to Bunds down to 140bps. That followed the weekend’s regional election in Emilia Romagna, where the populist nationalist League of Eurosceptic Matteo Salvini was defeated by the centre-left Democrats (PD), bolstering the ruling national coalition government of which the PD is a key member.

Looking ahead, today’s most notable economic data come from Germany, where the Ifo survey is expected to add to evidence of an improvement in the business climate at the start of the year – of course, whether that improvement will withstand the now-inevitable marked coronavirus-related Chinese slowdown this quarter is another matter. Over the remainder of the week, meanwhile, the economics calendar is very busy, including monetary policy meetings at the Fed (Wednesday, where the Fed Funds Rate target range is bound to be left unchanged but technical adjustments including news on the balance sheet might be announced) and BoE (Thursday, where the chances of a rate cut are less than 50% after Friday's stronger-than-expected PMIs). Data-wise, first estimates of Q4 GDP in the US (Thursday) and euro area (Friday) are due. Please see the details below…

Japan:
It was a quiet start to the week for Japanese economic data with no top-tier new releases. And the most notable releases of the week won’t come until Friday. Among the deluge of data due that day, December’s IP and retail sales figures are set to provide further insight into the likely pace of contraction in the economy in Q4. While manufacturing output is expected to have returned to positive growth at the end of last year, this is likely to reverse only a small part of the weakness seen earlier in the quarter – indeed, the forecast 0.7%M/M increase would leave output in Q4 down more than 4%Q/Q, which would mark the steepest quarterly drop since the height of the Global Financial Crisis. A further modest pickup in retail sales (circa 1%M/M) would also leave it down more than 5%Q/Q in Q4.

Friday will also bring the latest labour market figures for December, which are expected to show the unemployment rate tick slightly higher, albeit remaining close to a multi-decade low. Indeed, we might well see some payback for the solid employment growth seen in November. But while down from the multi-year high seen last year, the job-to-applicant ratio will likely move sideways (at 1.57x) signalling a still tight labour market. That day will also see the release of December housing starts and construction orders figures as well as Tokyo CPI inflation data for January, which are expected to show a drop of 0.2ppt to 0.7%Y/Y principally due to low inflation of fresh food - excluding such prices, the core inflation measures are expected to be stable (e.g. 0.8%Y/Y on the BoJ’s forecast measure).

The only other releases of note will come on Wednesday with January’s consumer confidence survey expected to point to further modest improvement at the start of the year. The BoJ’s summary of opinions of last week’s BoJ meeting will also be published that day.

Euro area:
This week will be a busy one for top-tier euro area economic data, with the flash estimates of Q4 GDP and January inflation (Friday) and the European Commission’s sentiment survey (Thursday) key releases. We currently expect euro area GDP growth to have slowed in Q4 to 0.1%Q/Q, down from upwardly revised growth of 0.3%Q/Q in Q3 and the softest since Q113. While Spain’s economy is likely to have continued to outperform other major member states, with growth likely steady at the 0.4%Q/Q pace seen in the previous two quarters, we expect growth in France to have slowed slightly by 0.1ppt to 0.2%Q/Q. And Italy’s economy likely went broadly sideways at the end of last year.

Friday will also bring the flash estimates of January inflation from the euro area, France and Spain, with the equivalent figures for Germany due on Thursday. We expect headline euro area inflation to have edged slightly higher at the start of the year, by 0.1ppt to 1.4%Y/Y due to higher energy prices. But with underlying price pressures still subdued, core inflation likely slipped back in January by 0.1ppt to 1.2%Y/Y.

After last week’s flash PMIs pointed to continued subdued growth, Thursday’s release of the European Commission’s economic sentiment survey – which provides the most comprehensive guide to euro area economic activity – will be closely watched. Thursday will also bring the euro area’s unemployment figures for December, with the headline rate expected to be unchanged at 7.5% for a third successive month.

The first half of the week will be filled mainly with national sentiment indicators, including the German ifo (today), German GfK consumer survey and Italian ISTAT business and consumer indices (Wednesday). Meanwhile, among other national releases, Germany’s labour market figures for January and retail sales data for December are also due Thursday.

UK:
The BoE’s policy announcement on Thursday will obviously be the main event for markets in the UK in the coming week. The prior two MPC meetings saw two external members – Haskel and Saunders – vote for a 25bp rate cut. And since the start of the year, three further members – Vlieghe, Tenreyro and Governor Carney, for whom this will be the final MPC meeting – have suggested that they would be ready to vote for a rate cut if the economic recovery anticipated in the BoE’s November base case forecast was unlikely to materialise. But while several recent lagging data releases, including December’s retail sales and inflation reports, were weaker than expected, the improvement in the flash January PMIs would suggest that the Bank’s updated forecasts will maintain a baseline of economic recovery from Q1 and inflation moving above target by the end of the projection horizon. Therefore, we expect Haskel and Saunders to remain the only two members to vote for a rate cut this week.

Economic data due this week include the CBI’s retail sales monitor (tomorrow), Lloyds business barometer (Thursday) and GfK consumer confidence survey (Friday), all for January. BoE bank lending figures for December are also due on Friday. And, of course, at 23.00 GMT that day the UK will leave the EU. Apart from losing its representation in EU decision-making, however, nothing of substance will change – the UK will continue to benefit from the rights and fulfil the obligations of EU membership throughout the transition period to last at least until the end of the year.

US:
It will, of course, be a busy week in the US too, with the conclusion of the Fed’s latest FOMC meeting (Wednesday) to be accompanied by several top-tier economic data, including the first estimate of Q4 GDP (Thursday).

Admittedly, the FOMC meeting looks set to be relatively uneventful, with the Fed Funds Rate target range bound to be left unchanged at 1.50-1.75%. However, the Fed might nudge slightly higher the interest rate on required and excess reserves from the current level of 1.55% to help move the Fed Funds Rate back to the middle of the target range. And it will also probably provide more information on its balance sheet policy, including updated plans for bill purchases and repurchase operations.

In terms of the Fed’s assessment of economic conditions, little might change. With the first-phase US-China trade deal having been signed since the Fed last met, and given tentative signs of improvement in certain domestic and overseas economic indicators towards the end of last year, Powell might well have been tempted to judge that downside risks had further moderated. But given the spread of the coronavirus, he might be more likely to refrain from such an assessment just yet.

Nevertheless, Thursday’s GDP release is expected to report continued steady expansion at the end of 2019, with growth in Q4 forecast to be little changed from the close to 2%Q/Q annualised rates seen in the previous two quarters. Other key releases this week include December durable goods orders data and January’s Conference Board consumer confidence survey (tomorrow), advance goods trade and inventories figures for December (Wednesday) and personal income and spending figures for the same month (Friday). Meanwhile, housing market releases include new home sales (today), Case-Shiller home price indices (tomorrow) and pending home sales figures (Wednesday).

Australia:
While today was quiet given today’s observation of the Australia Day holiday, a handful of new economic data releases are due over coming days. The most notable come on Wednesday in the shape of CPI data for Q4 and the NAB business survey results for December, both likely to be of interest to the RBA ahead of next week’s monetary policy decision. The inflation data are expected to come in softer than the RBA forecast in its November Statement of Monetary Policy. The Bloomberg consensus for the headline CPI rate is 1.7%Y/Y, unchanged from Q3 but 0.2ppt below the RBA’s forecast. And the trimmed mean CPI rate is expected to edge down 0.1ppt to 1.5%Y/Y, 0.1ppt below the RBA’s forecast. The NAB survey seems unlikely to suggest a significant improvement in conditions, although confidence might well have ticked higher in December on the back of improved perceptions of the external demand outlook. Of course, we would expect sentiment to have deteriorated more recently due to the intensification of the bushfires earlier this month and Chinese coronavirus concerns.

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