Broadened economic tensions with the US – weekly update 23 July

A look back over macroeconomic and market events for the week ending 20 July 2018. UK inflation disappointed as retail discounting offset a rising oil price, and the economic tensions with the US appeared to broaden from a trade war to a potential currency war. This week we have some PMI readings to look out for, and the latest European Central Bank monetary policy meeting.

UK inflation proved disappointing

UK inflation proved disappointing as the headline June CPI rate remained unchanged at 2.4% year on year (yoy). Markets had expected an increase to 2.6% following the recent sharp rise in the oil price, compared to a fall during the same period last year. But weakness in core inflation, which fell from 2.1% to 1.9% (no change was expected), offset this and was partly attributed to significant discounting via sales promotions, with Clothing & Footwear and Recreation & Culture sub-sectors the main detractors.

Coincidentally, UK Retail Sales missed forecasts, coming it at 2.9% yoy (3.5% was expected), but this comes after a particularly strong reading of 4.1% in May in what is a notoriously volatile series. So in reality, there is perhaps relatively little to read into. This weakness in core inflation continues to present something of a puzzle, with tight labour conditions emphasised by last week’s data which showed unemployment remaining at 4.2% (no change from a month earlier, as expected), and average weekly earnings growth of 2.5% yoy, as expected (though down from 2.6%).

The threatened economic warfare appeared to expand

The threatened economic warfare appeared to expand from a trade war to the early stages of a currency war last week. On Friday, China lowered the reference rate for the renminbi by 0.9%, the biggest one-day movement in the fix for two years, which saw the reminbi briefly move through US$6.80.

The Chinese currency has been steadily weakening versus the broadly-strengthening US dollar since April, and the move has accelerated since mid-June, which coincides with the intensification of the trade tensions with the US. The renminbi is now -7.4% weaker against the US dollar from the highs earlier this year, leading many to believe China may be weaponising its currency, counteracting US trade tariffs. Putting this in context, though, the renminbi is now trading back where it was last summer.

In typical fashion, Trump lashed out via Twitter, accusing China (and the Eurozone) of currency manipulation, while also lamenting the US Federal Reserve’s (Fed’s) monetary policy stance, appearing to blame the Fed for the strength of the US dollar. Officials were quick to point out that the president has no intention of interfering with the Fed’s independence.

Last week’s other events

• Chinese GDP slowed from 6.8% to 6.7% yoy as expected. Retail Sales growth accelerated from 8.5% to 9.0% yoy (8.8% was expected), but Industrial Production slipped from 6.8% to 6.0% (6.5% was expected). Fixed Asset Investment increased 6.0% year to date compared to the same period last year, as expected
• US Retail Sales growth cooled from 1.3% to 0.5% month on month (mom), as expected, whilst Industrial Production rebounded from -0.5% (downwardly revised) to 0.6% mom (0.5% was expected)
• Eurozone Construction Output accelerated from 1.2% growth (revised down from 1.8%) to 1.8% yoy in May
• In Japan, CPI inflation was unchanged at 0.7% yoy (an increase to 0.8% was forecast), whilst core inflation cooled from 0.3% to 0.2% yoy (0.4% was expected)

Markets

Equities appear to be ignoring the latest escalation in trade tensions for now, while core sovereign bonds witnessed a rare divergence, driven by specific local developments.

Equities

Equity markets drifted sideways. Japanese equities performed best, up 0.9% for the week as measured by the TOPIX. Europe (excluding the UK) rose 0.5% whilst the UK returned 0.2%, both based on the MSCI indices. Over in the US the S&P 500 was flat, whilst the MSCI Emerging Markets index slipped -0.1%.

Bonds

10-year gilts yields fell 4 basis points (bps) to 1.23%, driven by disappointing inflation figures, whilst 10-year US Treasury yields rose 7 bps to 2.89%. The equivalent German bund yields were 3 bps higher to 0.37%.

Commodities

Gold continued to weaken, falling to US$1,230 per ounce, whilst oil slipped from mid to low US$70s, ending the week at US$73.07 per barrel. Copper was slightly softer at US$2.75 per lb.

Currencies

Sterling fell against a basket of currencies through the week, triggered by the disappointing inflation reading – at one point sterling fell through US$1.30 before ticking back up towards the end of the week. Sterling closed on Friday at US$1.31, €1.12 and ¥146.

The week ahead

PMI numbers from the US and the Eurozone as well as the European Central Bank (ECB) monetary policy meeting are the main highlights this week. Starting with the ECB, no new policy announcements are expected after the key decision at the last meeting to announce the wind down of quantitative easing and introduce forward guidance on rates, though the press conference will be closely watched for any hints of the latest thinking around global economic developments and trade tensions. The key PMI releases are both on Tuesday with Eurozone PMI in the morning expected to see the Composite PMI slip from 54.9 to 54.8 (both Manufacturing and Services lower), and then US Markit PMI on Tuesday afternoon expected to show Services PMI unchanged at 56.5 but Manufacturing PMI cooling from 55.4 to 55.1. Thursday also gives us US Durable Goods Orders (3.0% mom from -0.4% expected). The daily breakdown is as follows:

Monday: A very quiet start to the week, with the only data of note being Eurozone Consumer Confidence (-0.7 from -0.5 expected) in the afternoon.

Tuesday: As well as the US and Eurozone PMI numbers, Japan will also report Manufacturing PMI. Just before lunchtime in the UK, the Confederation of British Industry will update the latest Business Optimism index reading, and later in the day in the US the Richmond Fed will report on its Manufacturing Index.

Wednesday: The only release of note midweek is the latest IFO business surveys in Germany, out in the morning (UK time).

Thursday: The ECB monetary policy meeting and US Durable Goods Orders are the key releases, and we will also get the Kansas City Fed Manufacturing Activity report.

Friday: There’s a quiet end to the week, with just the latest US GDP revisions of note in the schedule.