Currency volatility but ongoing economic strength – weekly update 29 January

A look back over macroeconomic and market events for the week ending 26 January 2018. Currency volatility was induced by some sharp words by US and European officials, whilst wider data releases pointed to ongoing economic strength. It’s a busy week ahead data-wise – US Non-Farm Payrolls are the usual highlight, with inflation and PMI data also of note.

Currency volatility fuelled by US and EU officials

Currency volatility was fuelled by pointed words from officials in the US and Europe last week as well as growing confidence – possibly misplaced – that the UK was heading more towards a soft Brexit, pushing sterling up to pre-referendum levels versus the US dollar.

At one point the US dollar was down as much as -3.36% against a broadly strengthening sterling. The trigger for the sharp US dollar fall mid-week was a comment at the Davos World Economic Forum from US Treasury Secretary Steven Mnuchin, who said “Obviously, a weaker dollar is good for us as it relates to trade and opportunities”. Markets and commentators jumped on this, pushing the US dollar down, and prompting indirect criticism from the European Central Bank (ECB) President, Mario Draghi, who suggested the comments ran against an international agreement to avoid talking down currencies.

In a bizarre twist, it was actually US President Donald Trump who intervened to calm the discourse, rightly highlighting that Secretary Mnuchin’s words were taken out of context, and that ultimately US economic strength would likely lead to a strong US dollar.

Against the euro/US dollar noise, sterling steadily appreciated amidst some positive comments – and more importantly an absence of negative comments – around future trade arrangements. From our strategy perspective, the recent sterling moves look rather optimistic.

UK growth ahead of expectations

UK GDP for the fourth quarter came in slightly ahead of expectations with 1.5% growth year on year (yoy). This was a slowdown from 1.7% previously (1.4% was forecast). Services activity, outside of retail, was especially strong, whilst construction remained in contraction as was the case for most of 2017.

But US growth falls short

US fourth-quarter GDP growth fell slightly short of expectations with annualised growth of 2.6% versus forecasts of 3.0% and down from 3.2% in the previous quarter. However, this was primarily driven by inventory drawdown with some contribution from net trade – consumption and investment remained robust.

A healthy global economic outlook

Other economic variables in the week also suggested a healthy global economic outlook. Eurozone Composite PMI rose from 58.1 to 58.6, with a boost to the services sub-index compensating for a slight dip in the manufacturing number.

The US PMI numbers from Markit registered a slowdown in the Services PMI from 53.7 to 53.3 (54.3 was expected), but Manufacturing PMI rose from 55.1 to 55.5 (55.0 was expected), and Durable Goods Orders rose from an upwardly-revised 1.7% month on month (mom) to 2.9%, defying forecasts for a slip to 0.8%.

No changes to monetary policy

As expected, there was no change to monetary policy from the meetings at the Bank of Japan and ECB, though there was plenty of discussion at the ECB press conference around communication on forward guidance as well as recent currency movements.

With regard to forward guidance, President Draghi was at pains to highlight that no meaningful discussions had taken place, and references in the minutes of the last meeting were little more than adding an agenda item for future discussion. At present the asset purchase programme is due to continue until September, and discussions will focus on whether to extend the programme, bring it to a sudden stop or taper it off.

Last week’s other events

• The UK labour market remained solid, with an increase of 102,000 people in employment for the November reading, recovering from a -56,000 fall previously and well ahead of expectations for a -12,000 fall. Weekly earnings held steady at 2.5% yoy growth, as expected. Elsewhere, the CBI reported business optimism rebounding from -11 to 13
• Japan saw CPI inflation rise from 0.6% to 1.0% yoy, just shy of the 1.1% forecast. Manufacturing PMI for December rose by 0.4 to 54.4, whilst the Leading Index of economic activity fell marginally from 108.6 to 108.3
• Eurozone consumer confidence rose from 0.5 to 1.3 (0.6 expected) and the ZEW Survey of business expectations rose from 29.0 to 31.8

The markets

It was a volatile week for currencies, with the weakening US dollar helping US equities and conversely putting pressure on European equities, whilst core sovereign bond yields generally ground higher.

Equities

As one might expect, the currency movements were having a notable impact on equity markets. Amid broad US dollar weakening, the S&P 500 rose 2.2% on the week. Conversely the MSCI United Kingdom slipped -0.7% and MSCI Europe (ex-UK) fell -0.3%. The Japanese TOPIX was down -0.6% and the MSCI Emerging Markets index rose 2.6%, all in local currency terms.

Bonds

UK 10-year gilt yields rose 10 basis points (bps) on the week, to finish at 1.44%, with 10-year German bund yields up 5 bps to 0.63% whilst the equivalent US Treasury yields were unchanged at 2.66%.

Commodities

Gold continued to find buyers, with the gold price rising to US$1,349.12 per ounce by the end of the week, whilst Brent Crude Oil was also stronger, finishing at US$70.52 per barrel. Copper was little moved at US$3.20 per lb.

Currencies

There were some very sizeable moves for currencies last week on the back of comments from various officials, with sterling stronger against the euro (0.6%) and especially the US dollar (1.9%), though it ended little changed versus the yen (0.13%). Sterling ended the week at US$1.42, €1.14 and ¥154.

The week ahead

It’s a busy week data-wise, especially from the US where we will have Non-Farm Payrolls and associated data on Friday (183,000 expected in January from 146,000 in December) as well as Janet Yellen’s last Federal Open Market Committee meeting concluding on Wednesday – though little is expected, and no press conference is scheduled. On top of that, we have inflation data from the US on Monday (PCE, 1.7% yoy expected from 1.8%) and the Eurozone on Wednesday (CPI, 1.0% from 0.9% expected). We also have the first estimate for Eurozone fourth-quarter GDP on Tuesday (forecast at 2.7% yoy from 2.6% previously) and PMI data from the UK and China (details below). The daily breakdown is as following:

Monday: As well as US PCE, we also have US Personal Income and Spending data released. Late in the evening Japan reports the Jobless Rate and Retail Sales.

Tuesday: Changes in UK Consumer Credit could be of interest in the morning. Along with Eurozone GDP, we also have Business and Consumer Confidence out from the trading bloc. In the afternoon, US Consumer Confidence from the Conference Board is reported, with Japanese Industrial Production reported later on.

Wednesday: A minute after midnight, the UK releases Consumer Confidence from GfK, the Lloyds Business Barometer and the Shop Price Index from the British Retail Consortium. After this, Chinese Non-Manufacturing PMI (54.8 from 55.0 expected) and Manufacturing PMI (no change at 51.6 expected) are reported. As covered above, Eurozone inflation is out later in the morning, and then in the afternoon the US ADP Employment Change will gather some attention ahead of Friday’s NFPs.

Thursday: Early morning, China reports Manufacturing PMI from the private Caixin survey (no change at 51.5 expected), and the latest UK House Price index is out later in the morning, followed by UK Manufacturing PMI (56.5 from 56.3 expected). US data in the afternoon include ISM Manufacturing PMI (58.6 from 59.7 expected) and Consumer Confidence from Bloomberg.

Friday: Ahead of the main NFP event, the latest UK Construction PMI reading is released (52.0 from 52.2 expected) and Eurozone PPI. In the afternoon, alongside the headline NFP number, we will be watching the Average Hourly Earnings (an increase by 0.1% to 2.6% yoy is expected), as well as labour force participation and Factory Orders.