Weekly multi-asset desk views
Weekly review: 12 April 2019
- It was a relatively quiet week for markets, with both global equities and government bonds ending the week broadly unchanged
- Chinese money supply and credit growth beat expectations while European industrial production also surprised positively
Market and economic review
Despite what was initially billed as a busy schedule this week, markets were remarkably sanguine. At the time of writing, global equities are set to finish the week almost exactly where they started, and there was little movement in between. This is likely due to the fact that there were no particularly ground-breaking developments from either central banks or economic data, and volumes were lower than average. This has meant that implied volatility levels have now dropped back close to year-to-date lows for equities, and the picture is similar, if not more extreme across other asset classes. Of particular note is FX volatility, where levels remain close to multi-decade lows for a number of major pairs. This is now even true for sterling (GBP) implied volatility, which collapsed this week following the Brexit developments discussed below. The standout performers were in the fixed income complex this week, with both credit and peripheral spreads grinding 10bp to 15bp tighter, aided by the European Central Bank (ECB) meeting and Brexit developments.
Growth data: Chinese monetary and credit data positive and green shoots in European industrial production
There were a number of interesting data points released in China this week, which provided further hope that growth has picked up. There was an upturn in both money supply (M1 & M2 growth both increased, beating consensus) and credit growth (new loans grew RMB1,690bn, also beating consensus for RMB1,250bn). We view Chinese financial conditions as an important lead indicator for global growth, and this data provides encouragement that easing measures carried out by Chinese authorities over the past year are having the desired effect. The trade data released in China over the week was more mixed, with exports increasing +14.2% (above consensus for +6.5%) but imports declining -7.6% (below consensus for +0.2% rise).
Europe is particularly sensitive to Chinese growth, and there was also some positive data from the continent, a rarity in recent months. Industrial production increased to -0.3% pa from -1.1% in January, also above the consensus of -0.9%. Italy was a particular standout, which surprised to the upside for the second consecutive month, expanding by +0.9% pa. Italian sovereign spreads tightened by up to 10bp across the curve.
In the US, core CPI unexpectedly fell to 2%, the lowest in 12 months. However, this was potentially distorted by a change in methodology used to collect apparel prices. US jobless claims declined to the lowest level since 1969. Neither of these releases saw a big market reaction and US treasury yields were not materially changed over the week.
Central Banks: ECB considers rate cuts while Fed remains on hold
There were two central bank events on Wednesday, with the ECB meeting/press conference and the Federal Open Market Committee (FOMC) minutes. While neither was particularly eventful, the ECB was the more interesting of the two. The ECB minutes confirmed that members are considering measures to mitigate the downsides of negative policy rates on the banking sector (such as ‘tiering’ the deposit rate), as well potentially opening up the possibility of further rate cuts. President Draghi also implied some tolerance for allowing inflation to rise above target. Core European yields barely changed over the week; however, European bank equities and European credit reacted positively.
In the US, the latest FOMC meeting minutes continued to highlight some diverging views within the committee. On balance, “most participants” expected economic weakness to be transitory and a “few” noted that pausing the hiking cycle could pose risks. As indicated by the recent ‘dot plot’, some participants feel further rate hikes will be appropriate later this year, while others noted that policy rates “could shift in either direction”. We expect the Fed to remain on hold in the medium term, until a clearer picture of domestic and global growth emerges.
Brexit: EU Council agree to 7-month extension
On Wednesday evening, the EU Council agreed to offer the UK a 7-month extension on Brexit through to October 31st. The clearest impact of this was a sharp reduction in the probability of a ‘no deal’ scenario, at least in the near term. This was reflected in 1mth sterling implied volatility levels, which fell over four points during the week – a considerable move. However, what was notable was the lack of direction in spot levels, and this reflects the myriad of potential outcomes still on the table. UK Prime Minister Theresa May told EU leaders that’s she is hopeful something can come of the cross-party talks, but there has been little evidence of an agreement so far. Given the length of extension, the potential for an early election continues to rise, with betting markets currently implying a 50% probability. So, while the ‘tail risk’ outcome has been kicked down the road, we expect plenty of political noise on the domestic front in coming weeks.
Trade: Positive noise on China, but is the EU next in the Trump administration’s firing line?
The week started with further positive developments on the US-China trade dispute, with US President Donald Trump’s economic adviser Larry Kudlow saying that the US and China are getting “closer and closer” to a trade deal. He added that they are coming close to resolving one of the key sticking points of the deal, saying: “we’ve made great progress on the IP[intellectual property] theft. We’ve made good progress on the forced transfer of technology”. While this is nothing concrete so far, news flow continues to suggest a deal is inching closer. We now think the majority of this has been priced in by risk assets and any challenge to this consensus could increase volatility.
That being said, there was a further reminder this week that President Trump’s trade war is not just limited to China. Overnight on Tuesday, the US Trade Representative Office released a list of EU goods that will be subjected to additional tariffs if the EU continues to provide subsidies to Airbus. The justification for this was the World Trade Organization (WTO) finding that EU aid has ‘repeatedly’ caused adverse effects to the United States. The market reaction to this was fairly subdued, likely because this relates to a long standing dispute – of around 15 years – between Airbus and Boeing, rather than a fresh escalation. However, what would certainly cause more of a stir in risk assets would be a negative announcement from Trump on the still-confidential 232 report. This relates to the imposition of auto tariffs with the EU, with the justification of a threat to US national security. An announcement on this is expected by May 17, so certainly one to watch.
Next week, there are a number of key growth releases for the market to digest. Regular readers will know the importance we assign to PMIs, so the preliminary readings in both Europe and the US released on Thursday will be our key focus. In China, we get the Q1 GDP reading on Wednesday, along with the monthly industrial production and retail sales numbers. It is likely that the latter will be more important in discerning global growth trends, particularly given the recent stabilisation in PMIs and rebound in credit growth. Other growth data includes US retail sales for March and the German ZEW survey.
The US earnings season also kicks off in earnest next week, with 15% of market capitalisation reporting. Expectations are for a -4% decline in EPS. This represents a sharp deceleration from Q4 earnings, and is partly explained by expectations for margin compression, as sales growth is expected to be positive at +4%. For us, the key focus will be on the asymmetry of price reaction to both beats and misses, and management commentary on the outlook for the rest of 2019.
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