Turkey is the epicentre of the latest financial crisis – weekly update 13 August

A look back over macroeconomic and market events for the week ending 10 August 2018. An escalating economic crisis in Turkey drove risk-off sentiment at the end of the week. On the macro side, UK second-quarter GDP provided few surprises, but data out of Japan were surprisingly strong. There are some mid-ranking economic data due this week, including UK inflation, wages and retail sales.

UK second-quarter GDP as expected

UK GDP for the second quarter was in line with expectations, rising 1.3% year on year (yoy), up from 1.2% in the first quarter, which perhaps doesn’t do justice to the pick-up in quarter-on-quarter (qoq) growth, which doubled from 0.2% in quarter one to 0.4% in quarter two. This was largely on the back of pent-up demand following the poor weather in quarter one (particularly in construction), so may represent something of a high point.

In the details, private consumption picked up less than expected, up from 0.2% to 0.3% qoq (0.4% was expected), whilst total business investment rebounded slightly more than expected, from -0.4% in the first quarter to 0.5% in the second (0.4% was forecast).

Trading activity unexpectedly contracted, with exports contracting -3.6% qoq (from 0%, 0.7% expected) and imports contracting -0.8% (from -0.5%, 0.8% expected). Services drove this economic growth, masking the fact that manufacturing had its worst quarter since 2012.

Japanese GDP rebounded

Japan’s GDP rebounded strongly in quarter two, all but confirming that the first-quarter fall was a blip. Second-quarter GDP increased at an annualised 1.9%, having contracted by -0.9% at an annualised rate in the first quarter (which was revised lower from -0.6%), and ahead of the 1.4% expected.

Private consumption (0.7% from -0.1%, 0.2% qoq expected) and business spending (1.3% from 0.5%, 0.6% qoq expected) were both ahead of expectations. This solid reading comes on the back of solid earnings growth that saw real cash earnings growth of 2.8% yoy in June, up from 1.3% previously and well ahead of the slip to 0.9% that was expected.

US core inflation at its highest since 2008

Headline CPI inflation in the US was unchanged at 2.9% yoy as expected, but the rise in core inflation puts this measure at its highest since 2008. Core CPI inflation (which excludes food and energy) picked up from 2.3% to 2.4% yoy (no change was expected) on the back of robust domestic demand, and despite a strengthening US dollar. Whilst still not our base case, injecting fiscal stimulus into an already buoyant economy would seem to increase risks to the upside for inflation.

Turkey is the epicentre of the latest financial crisis

Turkey is the epicentre of the latest financial crisis, catalysed by renewed pressure from the US over a pastor imprisoned in 2016 in the aftermath of an attempted coup. The lira was already suffering this year on the back of rising political and economic concerns, but the fall accelerated to a 13% drop on Friday alone which has focused minds on the issue.

The lira is now down 45% year to date, whilst inflation is running at 15.85%. However, the embattled Central bank left rates unchanged at its most recent meeting, possibly fearing the threatened intervention of President Erdogan.

Last week’s other events

• Eurozone Retail Sales growth cooled from 1.6% (revised up from 1.4%) to 1.2% yoy, against expectations for 1.4%. Investor Confidence picked up more than expected, from 12.1 to 14.7 (13.4 was expected)
• In Japan, the Composite PMI slipped from 52.1 to 51.8 as the Services PMI slipped from 51.4 to 51.3. Japan’s Leading Index slipped from 106.9 to 105.2 (105.3 was expected), while the Eco Watchers Survey Outlook measure was down to 49.0 from 50.0 (49.9 was forecast). Bank Lending slowed from 2.2% to 2.0% yoy growth
• UK Industrial Production growth increased to 1.1% yoy in June, with May’s reading revised up to 1.2% (0.7% was forecast)

The markets

After a mostly quiet week, there was some significant risk-off trading on Friday, particularly in core sovereign bonds, as concerns over Turkey’s economy intensified.

One-month performance of major asset classes in sterling terms

Equities

Equity markets were generally little moved on the week, at least until Friday when the troubles in Turkey manifested in Europe through concerns over banking exposure, which pushed the MSCI Europe ex-UK index down -1.3% for the week. The UK managed to grind out a 0.6% return (MSCI United Kingdom), whilst in the US the S&P 500 index slipped -0.2%. Japan fell -1.3% based on the TOPIX index, whilst the MSCI Emerging Markets Index was actually flat on the week.

Bonds

Core sovereign bond yields fell sharply on Friday, as investors sought ‘safe haven’ assets amidst the Turkish developments. 10-year US Treasury yields were down 8 basis points (bps) on the week to finish at 2.87%. In the UK, 10-year gilt yields fell 9 bps to 1.24% whilst the equivalent German bund yields were also down 9 bps to 0.32%. 10-year Japanese government bonds continued to hover at 0.10%, not looking to test the new tolerances from the Bank of Japan. Whilst core yields were falling, peripheral European bond yields crept higher, given potential contagion worries, though the moves were limited.

Commodities

The commodity complex was fairly subdued last week. Gold was only fractionally down at US$1,210.57 per ounce, while oil was very slightly weaker, closing at US$72.81 per barrel (Brent Crude) and copper slipped to US$2.75 per lb.

Currencies

Sterling continued to slide last week, slipping -0.5% against the also-falling euro, and down -1.9% against the US dollar, whilst the yen was notably strong. Sterling closed on Friday at US$1.28, €1.12 and ¥141.

The week ahead

There are a few points to watch out for this week. Overnight on Tuesday, China will release its latest batch of data including Industrial Production, Retail Sales and Fixed Asset Investment. Later on Tuesday morning, we will have UK labour data, where markets are expecting Average Weekly earnings growth to be unchanged at 2.5% yoy. On Wednesday UK CPI inflation is reported, expected to have ticked up 0.1% to 2.5% yoy. Wednesday will see US Retail Sales figures (expected to have fallen from 0.5% to 0.1% month on month) followed by UK Retail Sales on Thursday (no change at 2.9% expected). The daily breakdown is as follows:

Monday: It’s a very quiet start to the week, with no releases of note scheduled.

Tuesday: In the overnight data release from China, markets are expecting Retail Sales to have picked up from 9.0% to 9.1% yoy, whilst Industrial Production is expected to have increased from 6.0% to 6.3% yoy. Fixed Asset Investment is forecast as unchanged at 6.0% yoy. After the UK labour numbers, the Eurozone will report June Industrial Production (no change at 2.4% yoy expected), followed by the output from the ZEW Economic Surveys.

Wednesday: UK CPI inflation is the main point of interest, and the associated data, such as the Producer Prices Index could also be revealing. In the afternoon, in addition to Retail Sales, the US will also report on Industrial Production (a slowdown from 0.6% to 0.3% month on month is expected), Capacity Utilisation and Business Inventories.

Thursday: As well as UK Retail Sales, the latest Eurozone Trade Balance will be reported, and then in the afternoon the Philadelphia Federal Reserve releases its business outlook.

Friday: The week ends almost as quietly as it started, with only the University of Michigan consumer survey output of any note.