Weekly macroeconomic and market update – 12 December 2016

A look back over macroeconomic events for the week ending 09/12/2016. The European Central Bank (ECB) added some creativity to its monetary policy and there were signs of temporary stabilisation in China. A busy week lies ahead, in which the Federal Reserve (Fed) is expected to hike rates, the Bank of England is likely to hold a steady course and we get a lot of data out of China and the US.

Are Central banks running out of ammo?

The ECB threw something of a curveball on Thursday, reducing the monthly level of Quantitative Easing by €20 billion (to €60 billion) per month from April, while also extending the programme by at least nine months. These conflicting signals initially caused some confusion in the markets: was this tapering or stimulating?

In the end, markets broadly settled on the latter, with equity markets rallying later in the day. Amid concerns that the ECB would soon struggle to find things to buy, the scope was also broadened to include bonds with shorter maturity and yields below the deposit rate (currently -0.40%) – the net result was a steepening yield curve, with short-dated bund yields falling whilst the longer end rose. Despite the positive reception, this is clearly another warning sign that the efficacy of ultra-loose monetary policy is falling. Central banks are running out of ammunition, and they know it, even if the broader market appears to be choosing to ignore that fact.

Poor UK data but China’s economy could be stabilising

There was some surprisingly poor data out of the UK as industrial production in October fell -1.1% year on year, the worst reading since August 2013, and an acceleration of the slowdown from the summer. Consensus had been for an improvement from 0.4% to 0.5% growth, but a sharp slowdown in October (-1.3% month on month from -0.4% previously and 0.2% growth expected) put pain to that. Manufacturing production similarly disappointed, falling -0.4% year on year (from 0.1% growth in September and forecasts for 0.8%). There was slightly better news from the construction industry as construction growth slowed from 2.5% year on year in September to 0.7% in October, but forecasts had been for a -0.1% contraction. There was some good news in the Services PMI reading for November, which improved from 54.5 to 55.2, against forecasts for a decrease to 54.0.

Positive data out of China suggested conditions in the world’s second largest economy could be stabilising, albeit temporarily. Services PMI improved from 52.4 to 53.1 (52.7 expected) as measured by the private Caixin survey. Trade data also unexpectedly stabilised – exports were up 0.1% year on year (from -7.3% and forecast of -5.0%) whilst imports were up a mighty 6.7% (from -1.4% and forecasts for -1.3%). Inflation was also higher – headline inflation rose 2.3% year on year (from 2.1% previously, 2.2% forecast), whilst PPI surged to 3.3% (from 1.2% and forecasts of 2.2%).

Last week’s other events

• The ECB refused to give more time for the private-sector led bail-out of Monte dei Paschi, the beleaguered Italian bank, in the aftermath of the Italian referendum which saw Prime Minister Renzi resign. A government bail-out will probably now be required, but this will be subject to unpopular new EU rules which are punitive on existing creditors, which includes many ordinary Italian citizens.

• The UK Supreme Court finished hearing legal challenges around Parliamentary involvement in starting the process to leave the EU, in the wake of the Brexit vote. The outcome, promised “as soon as possible”, could impact perceptions of whether the UK will have a ‘hard’ or ‘soft’ Brexit.

• Eurozone retail sales were stronger in October, growing at 2.4% year on year (from 1.0% in November and ahead of expectations for 1.7%).

• US Non-Manufacturing PMI moved higher in November, from 54.8 to 57.2 (55.4 expected). The Michigan Consumer Sentiment survey index also improved from 93.8 to 98.0 (94.5 expected).

The markets

It was another risk-on week, with equities pushing higher on the week and oil benefiting from the latest production cut agreements, whilst government bonds and gold continued to sell-off.

Equities

Equities rallied during the week, with European equities leading the major indices returning 5.1%, as measured by the MSCI Europe ex-UK index. UK equities were up 3.5% (MSCI United Kingdom) whilst the S&P 500 index in the US gained 3.1%. In Japan, the Topix index returned 3.2% and in Hong Kong the Hang Seng index advanced 0.8% during the week.

Bonds

Ten-year gilt yields were another 9 bps higher to end the week at 1.46%, and ten-year US treasury yields were up 7bps to 2.47%. In Germany, we saw a steepening of the yield curve, ten-year bund yields were 9 bps higher to 0.37%, whilst ten-year yields fell another 2 bps to -0.76%; bunds maturing in one month now have a negative yield in excess of 1.0%.

Commodities

With expectations of oil supply cuts remaining very much alive following agreements over the weekend, oil remained relatively strong last week, Brent crude closed the week at US$54.33/barrel. Copper also held onto recent gains finishing at US$2.65/lb, but gold remained under pressure, slipping to US$1,158.40/ounce.

Currencies

Performance generally followed the relative monetary policies of respective Central banks. Sterling and the US dollar, which are now both essentially thought to be on a tightening monetary policy cycle, albeit to different magnitudes, were stronger whilst the euro and yen, both with weakening monetary policy trajectories, were weaker. Sterling ended the week at US$1.26, €1.19 and ¥145.

The week ahead

There’s actually quite a lot going on this week, even as many people will be winding down for Christmas, with two Central bank meetings and a range of economic data releases.

The main event is expected to be the US Federal Reserve meeting on Wednesday, with expectations for a hike now at 100%. The Fed’s latest economic projections will also be released. The following day on Thursday the Bank of England’s MPC meeting concludes, though following earlier stimulus measures and a recent change in some of the language, we’re unlikely to see any activity here. China releases some useful data, with Foreign Direct Investment out on Monday morning, then Fixed Asset Investment, Industrial Production and Retail sales out in the early hours of Tuesday morning. The US will also be releasing retail sales and industrial production on Wednesday, ahead of the Fed meeting – forecasts are that retail sales will have slowed from 0.8% to 0.3% month on month in November, and Industrial Production will shrink -0.1% from the 0% reading for October.

Monday: There is little else of particular note scheduled, other than Chinese FDI.

Tuesday: UK inflation is released in the morning – headline inflation is forecast to be up 0.2% to 1.1% year on year, with core up 0.1% to 1.3%. Also in the morning, Eurozone employment and the ZEW economic surveys covering the Eurozone and Germany will be released. In the afternoon, US import and export prices are reported, then late in the evening the Tankan Large Manufacturers index in Japan will be updated.

Wednesday: UK employment data is released in the morning, as is the Eurozone industrial production reading for October. All eyes will be on the US in the afternoon, as Retail Sales and Industrial Production are released (mentioned above), as well as associated data, including business inventories and PPI changes, before the Fed announcement in the evening.

Thursday: Eurozone Flash PMI readings for both Manufacturing and Services are released in the morning, as are UK retail sales figures, before the Bank of England meeting output is presented at midday. Further US data are released in the afternoon, including inflation, manufacturing PMI and both the New York Empire State and Philadelphia Fed manufacturing indices.

Friday: Eurozone balance of trade figures and UK industrial trends from the CBI are out in the morning. In the afternoon US building permits and housing starts are the only data of note to see the week out.