Sterling strengthens on the back of Brexit talks
The appearance of some positive movement on Brexit talks helped sterling gain further strength with Prime Minister Theresa May reportedly ready to increase the divorce payment from €20 billion to €45-55 billion, which would help negotiations move past a major stumbling block.
There were also encouraging data from the UK Manufacturing sector, as Manufacturing PMI moved sharply higher from 56.6 to 58.2 (56.5 was expected). This was helped by strength in new orders, particularly capital equipment, and a rebound in exports.
The Bank of England also used its annual stress tests – which all banks passed – to raise the counter-cyclical buffer another 0.5% to 1.0%, as authorities continue to prepare the banking system to weather the next downturn.
A dip in US manufacturing
By contrast, US Manufacturing PMI numbers dipped on the ISM measure from 58.7 to 58.2 (58.3 had been forecast). This was primarily caused by a sharp fall in the supplier deliveries component, likely a knock-on from the recent hurricane effects – new orders and production levels both moved higher. As a result, despite the slip in the reading, the overall level is still elevated and signals ongoing robustness in the economic outlook.
An element of this was also reflected in the upward revision to third-quarter GDP from 3.0% to 3.3% annualised, the highest reading since 2014. But again, this comes with a caveat: the revision was driven by inventory building, which can be something of a false signal, and should be reversed next quarter.
US tax reform progresses
US tax reform also progressed over the weekend, as the Senate narrowly passed their version of the tax bill early on Saturday morning, after extended negotiations with holdout Republican senators. It was hardly the cleanest process, relying on hand-written notes in the final document presented to the Senate and a host of procedural trickery, but it was enough to get through with a vote of 51-49.
The legislation now needs to be combined with the House version before it can pass into law. Although there are some differences between the bills, particularly on individual tax deductions, both bills support slashing the corporate tax rate to 20% (from a notional 35% currently, though the effective rate for most US corporations is lower), providing a boost to US equities.
Last week’s other events
Japan’s Retail Sales fell -0.2% year on year (yoy) in October, down from 2.2% previously and worse than the 0.2% forecast. Industrial Production rebounded from 2.6% to 5.9% yoy, but still disappointed punchy expectations for 7.1% growth. CPI slipped as expected from 0.7% to 0.2% yoy.
China’s official Manufacturing PMI was marginally higher, up from 51.6 to 51.8 (a slip to 51.4 was forecast), whilst the Caixin Manufacturing PMI measure slipped from 51.0 to 50.8 (50.9 was expected). Official Non-Manufacturing PMI rose from 54.3 to 54.8.
In the UK, the British Retail Consortium reported that like-for-like shop prices fell -0.1% yoy in November, the same as the previous month. Consumers aggregated another £1.5 billion net to their credit bills, whilst Consumer Confidence fell from -10 to -12 (-11 expected), as did the Lloyds Business Barometer (to 24 from 26).
Eurozone CPI inflation rose 0.1% to 1.5% yoy, but was just shy of forecasts for 1.6%, whilst the Core CPI measure was unchanged at 0.9% (1.0% was expected). Unemployment fell from 8.9% to 8.8% (no change was expected).
US Personal Income was unchanged at 0.4% month on month (mom) ahead of the 0.3% expected, whilst Personal Spending slipped from 1.0% to 0.3% mom, in line with forecasts. Consumer Confidence rose from 125.9 to 129.5, ahead of an expected slip to 124.0.
A lot of politics appeared to drive markets last week. News that the UK would increase its Brexit ‘divorce bill’ helped push sterling up (but UK equities down), and progress on US tax reform provided a boost to US equities. Friday also saw some markets spooked by the latest developments in the US’s probe on Russian election interference.
By recent standards, there was a surprising degree of differentiation across the regions. The US ended the week on a high, as the prospect of tax reform legislation passing moved steadily closer to reality – the S&P 500 was up 1.6% by close on Friday. Against that, European equities had a tougher time. In the UK, the MSCI United Kingdom slumped -1.3%, not helped by sterling strength, whilst the MSCI Europe ex-UK index fell -1.0%. The TOPIX index of Japanese equities was also stronger, rising 0.9% whilst Emerging Markets suffered with a fall of -3.2%.
Sovereign bond yields had generally been moving higher through the week, but fell back sharply on Friday with the news regarding General Flynn and the US/Russia probe. UK 10-year gilt yields fell 10 basis points (bps) on Friday, to finish at 1.23% (though that is only 2 basis points lower than the start of the week). German 10-year bund yields were 5.5 bps lower on the week to finish at 0.31%. US Treasuries were the exception, with yields on the 10-year rising by 2 basis points overall to close at 2.36%, driven by developments on tax reform.
Oil ended the week broadly where it started at US$63.73 per barrel based on Brent Crude. In metals, gold weakened to US$1,280.62 per ounce and copper fell to US$3.07 per lb.
With the announcement of a potential breakthrough on the Brexit divorce bill, sterling rallied, rising 1-1.5% against other major currencies by the end of the week. Sterling closed on Friday at US$1.35, €1.13 and ¥151.
The week ahead
There’s quite a lot of data out next week, with US Non-Farm Payrolls on Friday the usual highlight. On Tuesday, Services PMI from Japan, China, the UK and US (ISM Non-Manufacturing for the US) are reported, along with Eurozone Retail Sales (a slowdown from 3.7% to 1.6% yoy is expected). Ahead of NFPs on Friday, the UK will report Industrial Production, which is expected to support recent economic signals with an acceleration from 2.5% to 3.5% yoy growth. There is also plenty on the political front to watch out for, including major high-level Brexit meetings, follow-up activity in the US around both the tax reform and Michael Flynn, and German coalition talks. The daily breakdown is as follows:
In the morning, UK Construction PMI is forecast to have risen by 0.2 to 51.0, and this will be followed by Eurozone PPI inflation, expected to have dipped from 2.9% to 2.6% yoy. In the afternoon, US Factory Orders are reported.
Just after midnight, the British Retail Consortium reports like-for-like sales growth, followed by Japanese and Chinese Services PMI, as covered above. 9am UK time sees Eurozone Services PMI, which are forecast as unchanged at 56.2. In contrast to Manufacturing, UK Services PMI is expected to have slipped from 55.6 to 55.0. After Eurozone Retail Sales, US Non-Manufacturing PMI from ISM is expected to fall from 60.1 to 59.0.
A quiet day mid-week, with only Germany’s Factory Orders and the US ADP Employment change of any note, the latter often used as a prelude to the main event on Friday.
Overnight, Japan reports the October readings for its Leading and Coincident Index indicators. Later in the morning, revisions to Eurozone Q3 GDP are released, with the same for Japan late in the evening.
Most of the action in the week, at least as far as the data schedule goes, is on the last day. In the morning, UK Industrial Production numbers are out. In the afternoon, for US Non-Farm Payrolls the market is looking for 199,000 jobs added in November, down from 261,000 in October. No change is expected in the unemployment rate, but average hourly earnings are expected to be 0.3% higher to 2.7% yoy, and any miss here could have a notable market impact, given the sensitivity on the outlook to wage-push inflation. Finishing the week off, the University of Michigan will give its latest sentiment reports.
This article was previously published on Tilney prior to the launch of Evelyn Partners.