A dovish hike and mixed Non-Farm Payrolls weekly update 6 November 2017

The Bank of England’s dovish hike

Our note from last week has more detail, but in summary there was little surprise in the announcement, which had been flagged well in advance. However, the supporting commentary was a little more dovish than many had expected. The Bank of England now joins other major Central banks such as the US Federal Reserve and the European Central Bank in gradually withdrawing the ultra-loose monetary stimulus that has been the norm since the Global Financial Crisis.

There are now only two more rate hikes expected over the next two years, with the next one not expected in the next 12 months. This withdrawal should be gradual enough to have very little direct impact on the economy, but it does mean that markets that have fed off liquidity for several years will need to be driven instead by fundamentals.

Jerome Powell was announced as the next US Federal Reserve Chairman

Powell succeeds Janet Yellen and saw off rival John Taylor. The selection had been increasingly expected in the last few weeks, and markets took the announcement in their stride. This is particularly as Powell, who has been a Federal Reserve (Fed) Governor since 2012, is seen as a continuity candidate. Of more interest was the proposed tax reform that the Republicans will try to get through the House this week.

The bill moves further than expected, with an immediate and permanent cut to the US corporate tax rate from 35% to 20% (a phased cut had been in discussion) and relief for business expenses, partially offset by a one-off 12% tax on overseas retained earnings held in cash and a reduction in the deductibility of interest payments. One of the most controversial elements was the end of mortgage payment deductibility for wealthier Americans (those buying homes worth more than US$500,000, compared to a US$1 million limit previously), which is likely to be an early target for amendment by lawmakers.

US non-farm payrolls were a mixed bag

These will be largely written off as noise as the data normalise following the hurricane impacts. Whilst the headline number of 261,000 jobs added was somewhat below the 313,000 expected, it came with upgrades to the previous two months, meaning that September actually saw a small net gain of 18,000 (compared to the fall of 33,000 originally highlighted). Average hourly earnings were a disappointment, falling from 2.9% to 2.4% year-on-year growth, but as we highlighted last month these figures are likely to be distorted by lower-wage jobs being disproportionately impacted by the hurricanes in September, and coming back to the workforce in October.

Unemployment fell 0.1% to 4.1%, with underemployment (mostly those in part-time work who would like to work full-time) down from 8.3% to 7.9%. However the participation rate dropped from 63.1% to 62.7%. Overall, there is every reason to ignore this short-term noise, but few reasons to be much more positive at this stage.

Last week’s other events

• UK consumers added another £1.6 billion to their combined credit bills in September, whilst consumer confidence, as measured by GfK, slipped 1 point to -10. The business sector appeared more optimistic, as the Lloyds Business Barometer increased 3 points to 26. PMI readings were also good, as the Manufacturing PMI rose from 55.9 to 56.3 (no change was expected), and Services PMI rose two whole points from 53.6 to 55.6 (a slip to 53.3 had been expected). Construction PMI also surprised, moving back into expansionary territory with a reading of 50.8 (from 48.1, 48.5 expected).
• US Personal Consumption Expenditure (PCE) inflation, the Fed’s preferred measure, rose from 1.4% to 1.6% year on year, in line with forecasts. Core inflation was unchanged at 1.3% as expected. Personal Incomes rose from 0.2% to 0.4% month on month as expected, whilst Personal Spending rose from 0.1% to 1.0% (0.9% was forecast). Consumer Confidence, measured by the Conference Board, rose from 119.8 to 125.9 (121.5 was expected).
• Eurozone GDP growth accelerated to 2.5% year on year in the third quarter, from 2.3% previously, and beating expectations for 2.4%. Inflation fell from 1.5% to 1.4% year on year (no change was expected), and core inflation fell even further, to 0.9% (from 1.1%, no change expected). Business confidence picked up, rising from 113 to 114 (no change was expected).
• Japanese Retail Sales rebounded from -1.7% to 0.8% month on month in September. Industrial Production cooled from 5.3% to 2.5% year on year, but beat forecasts for 2.0%. At its Monetary Policy Meeting, the Bank of Japan left rates unchanged.

The markets

Major sovereign bonds rallied through the course of the week, with gilts making their big move on Thursday following the Bank of England announcement. Equity markets were positive but muted.

Equities – Equity returns were subdued last week, with most markets drifting slightly higher. Japan was the strongest performer again, with the TOPIX index rising 1.3%, with continental Europe (MSCI Europe ex-UK) just behind at 1.0%. The MSCI United Kingdom index returned 0.9%, whilst the US was the relative laggard, up just 0.3% on the week (S&P 500). Emerging Markets also made a small gain, as the MSCI Emerging Markets index rose 1.2%.

Bonds – Gilt yields fell sharply on Thursday following the dovish hike, with the 10-year yield down 9 basis points (bps) to 1.26%. 10-year US Treasuries yields were also lower, down 7 bps to 2.33%, whilst the equivalent German bund yields were down 2 bps to 0.36%.

Commodities – Oil continues to edge higher, with Brent Crude rising to US$62.07/barrel by the end of the week. Gold and copper barely moved on the week – gold was down just over US$3 to US$1,269.91/ounce, whilst copper was up just over 1 cent, to US$3.12/lb.

Currencies – There was a notable sell-off in sterling on Thursday, though mostly this simply gave up gains made earlier in the week, whilst other currencies remained subdued over the period. Sterling closed on Friday at US$1.31, €1.13 and ¥149.

1 month performance of major asset classes

Source: Lipper for Investment Management

The week ahead

After a very busy week, the release schedule is much quieter this week, though with the US tax legislation being developed in Congress this week and the US President on a tour of Asia, there is likely to be plenty of noise on the political front. Of what data there are, Tuesday’s Eurozone Retail Sales (expected to have rebounded from 1.2% to 2.8% year on year), Chinese trade data on Wednesday and UK Industrial Production (1.9% from 1.6% year on year expected) are the main points to watch. The daily breakdown is as follows:

Monday: Japan reports Services PMI early in the morning, then later the UK has New Car Registration data and the Eurozone reports the latest Producer Prices Index (PPI).

Tuesday: Japanese earnings data are reported at midnight, and then the British Retail Consortium posts the latest Like-for-Like Sales data a minute after midnight. Later in the morning, UK House Price data is published from Halifax and then Eurozone Retail Sales numbers are out, as covered above. In the afternoon from the US, we have the latest JOLTS Job Openings numbers and Consumer Credit to look forward to.

Wednesday: Aside from Chinese trade data, the main data are from Japan, which reports Leading and Coincident indices, Core Machine Orders and Bank Lending data.

Thursday: China reports inflation overnight (CPI inflation forecast to have rising from 1.6% to 1.7%), followed by Japan’s Eco Watchers Survey results. The European Commission then publishes its latest economic forecasts.

Friday: UK Industrial Production figures (covered above) will also come with details around manufacturing and construction activity, which could be of interest, as will the UK Trade Balance. In the afternoon, the University of Michigan reports on current sentiment and expectations to see the week out.