Is economic momentum fading? – weekly update 7 August

A look back over macroeconomic and market events for the week ending 4 August 2017. Cautious tones from the Bank of England were countered by a positive jobs report in the US, but overall indications suggest some economic momentum may be fading. After last week’s activity, the schedule is especially quiet for the week ahead.

The Bank of England’s Super Thursday

Super Thursday saw the Bank of England (BoE) cut its growth forecast, prompting sterling to fall and government bonds to rally. In the latest quarterly Inflation Report the BoE cut its forecast for 2017 GDP by 0.2% to 1.7%, along with a 0.1% downgrade for 2018 (to 1.6%), whilst leaving its 2019 projection unchanged at 1.8%.

The Bank cited, in particular, the squeeze on household consumption as Brexit-related inflation pushes retail prices up, whilst wages remain under pressure and businesses have been eschewing investment activity – elements we’ve highlighted previously as areas of concern.

In terms of policy, the committee voted 6-2 to keep rates unchanged, slightly more dovish, as expected, now that the relatively hawkish Kristen Forbes has been replaced on the committee. Despite the dovish nature of this particular meeting, we still believe that the Bank is looking to tighten policy from here – albeit on a very gradual basis. Indeed, the Bank’s statement explicitly highlighted that, on the current projection, “policy could need to be tightened by a somewhat greater extent… than the path implied by the yield curve underlying the August projections”. As a result, we believe UK government bonds still look vulnerable at longer durations, and we retain low duration exposure within our fixed income allocations.

Non-farm payrolls beat expectations again

The headline non-farm payrolls (NFPs) beat expectations once again, with 205,000 jobs added in July compared to 180,000 forecast, whilst unemployment fell 0.1% to 4.3% as expected. The participation ratio also rose 0.1% to 62.9%.

Average hourly earnings remained unchanged at 2.5% year on year (yoy), slightly beating expectations for a slip to 2.4% and providing some tentative signs that meaningful and sustained wage pressure may be starting to build.

Despite these solid employment data, though, other economic data gave reasons to pause. The ISM Manufacturing PMI fell from 57.8 to 56.3 (56.5 was expected), whilst the Non-Manufacturing measure fared even worse, falling from 57.4 to 53.9 (56.9 expected). Personal income was disappointing, with no month-on-month (mom) increase in June, from 0.4% previously and forecasts for the same again in June.

In the round, it remains likely that the Federal Reserve (Fed) will continue to tighten monetary policy, albeit at a very gradual rate. We expect a balance sheet reduction to be announced in the second half of the year, with the Fed likely to allow this new approach to bed in before considering fresh interest rate hikes.

Last week’s other events

• Japanese industrial production grew at 4.9% yoy in June, down from 6.5% in May but slightly ahead of the 4.8% forecast. Services PMI was 1.3 points lower at 52.0. Real cash earnings disappointed as they fell -0.8% yoy (from 0.1% with expectations of the same).
• China released the latest PMI figures. The official measure of Manufacturing PMI slipped 0.3 points to 51.4 (51.5 expected), whilst Non-Manufacturing was 0.4 points lower at 54.5. In contrast, the private Caixin measure of Manufacturing PMI rose 0.7 points to 51.1 (no change at 50.4 was expected), and the Services PMI measure was 0.1 lower at 51.5.
• UK Consumer Credit increased another £1.5 billion in June, in line with expectations, and slightly below the £1.7 billion added in May. This gives an annual growth rate of 10%, which remains high, but is showing signs of moderating. Manufacturing PMI increased from 54.3 to 55.1 (54.5 was expected), and Services PMI rose from 53.8 to 54.1 (forecast was for no change at 53.8).
• Eurozone GDP increased 2.1% yoy in the second quarter, in line with expectations and up from 1.9% previously. CPI inflation was unchanged at 1.3% yoy, whilst Core CPI rose 0.1% to 1.2% (no change at 1.1% was expected). Unemployment dipped more than expected to 9.1% (from 9.3%, 9.2% forecast). Retail Sales were boosted to 3.1% yoy (from 2.6%, ahead of expectations for a slip to 2.5%).

The markets

Pan-European equities had a reasonable week, in context of the current low-volatility environment, whilst core sovereign bonds ended slightly up (yields down) after digesting the BoE output and US NFPs. Sterling was weaker, whilst gold also suffered.

One month performance of major asset classes

Equities

Pan-European equities had a strong week, as UK equities returned 1.9% (MSCI United Kingdom), while the rest of Europe (MSCI Europe ex-UK) gained 1.3%. US equities were more subdued as the S&P 500 rose just 0.2% on the week, and it was a similar story in Japan where equities returned 0.6% on the TOPIX index measure. The MSCI Emerging Markets index also returned 0.6%.

Bonds

Core sovereign bond yields were down overall on the week, with most falling in sympathy with gilts following the BoE output before bouncing to varying degrees on Friday after US NFPs. By the close on Friday, 10-year UK gilt yields were down 4 basis points (bps) on the week to close at 1.18%, equivalent US treasuries were down 3 bps to 2.26% and 10-year German bund yields had slipped 7 bps to 0.47%.

Commodities

Oil was relatively unchanged with Brent crude ending the week at US$52.42 per barrel. Copper was in a similar situation, barely changed at US$2.89 per lb. Gold was weaker and finished at US$1,258.88 per ounce, mostly caused by a sharp move down after the NFPs on Friday.

Currencies

Sterling slipped across the board after the BoE releases, whilst the euro continued to strengthen. Sterling ended the week at US$1.30, €1.11 and ¥144.

The week ahead

After last week’s activity, there is a bit of a lull this week. China releases trade data on Tuesday, including import and export data, as well as Foreign Direct Investment, with inflation data out on Wednesday. In the UK, Industrial Production figures are released on Thursday, with another contraction expected at -0.1% yoy from -0.2% previously. US CPI inflation is out on Friday (an increase from 1.6% to 1.8% is expected). The daily breakdown is:

Monday: Japan releases the Leading Indicator and Coincident Index economic gauges early in the morning, and then US Consumer Credit data are released later in the day.

Tuesday: Just after midnight, the British Retail Consortium releases sales data, which will be followed by data out of Japan, including the latest balance of payments and bank lending activity as well as the Eco Watchers economic survey. The afternoon has JOLTS Job Openings data, before the Chinese trade data mentioned above.

Wednesday: Chinese CPI in the morning is expected to remain unchanged at 1.5% yoy, whilst the afternoon sees official Q2 data from the US estimating productivity and labour costs.

Thursday: More data is released from Japan, including Machine Orders, the Tertiary Industry Index and PPI. After UK Industrial Production (covered above), the US releases Initial Jobless Claims numbers and PPI data.

Friday: CPI data from the US are the main data of note at the end of the week. As well as the headline rate, the Core figure will be closely watched, with forecasts for no change at 1.7% yoy.