Politics in the driving seat – weekly update 5 March

A look back over macroeconomic and market events for the week ending 2 March 2018. Politics were in the driving seat this week as US President Donald Trump sparked fears of a trade war and the Italian election appeared to heavily favour anti-establishment parties. It’s a busy week ahead with the US labour market report on Friday and monetary policy meetings at the European Central Bank and Bank of Japan.

Concerns of a trade war

President Trump announced his intention to impose tariffs on steel and aluminium imports, sparking concerns of a trade war from economists and investors the world over. The reported tariff levels were 25% on steel and 10% on aluminium. In themselves these are relatively limited, but politics is about signalling – and the announcement has already sparked a war of words with Eurozone officials.

Rising US protectionism and the associated risk of a trade war are points we have highlighted before, and more recently in our February Pulse publication, so we will watch developments here closely.

Eurozone politics

Angela Merkel managed to secure her fourth term as German Chancellor, with the Social Democratic Party (SDP) membership voting in favour of forming a coalition with Ms Merkel’s Christian Democratic Union/Christian Social Union (CDU/CSU) bloc. While this now allows Germany to get on with the day-to-day business of governing, the Chancellor is likely to be somewhat politically weakened in what is expected to be her last term.

Overnight we have seen another bloody nose for mainstream political parties in Italy where no group appears to have enough votes to secure an overall majority and anti-establishment parties have made significant gains. The populist Five Star Movement, led by comedian Beppe Grillo, won the largest single party share with 32% of the vote. Silvio Berlusconi’s centre-right coalition secured 37% of the vote – shy of an absolute majority and with a strong gain for the anti-immigration, Euro-sceptic Northern League, beating Mr Berlusconi’s Forza Italia to become the largest party in the coalition.

All parties have been calling for an end to austerity. The success of the anti-establishment parties suggests more radical policies may be in the offing, potentially setting Rome on a collision course with Brussels, a theme we also highlight in the February Pulse.

Unexciting inflation readings

Inflation readings from Europe and the US were unexciting, while other economic data were mixed. Eurozone CPI inflation dipped 0.1% to 1.2% year on year (yoy) as expected, with core CPI holding steady at 1.0%, also as expected.

Over in the US, the Federal Reserve’s preferred PCE measure of inflation was unchanged for both the headline and core readings, coming in at 1.7% and 1.5% yoy respectively, both in line with expectations. The US ISM Manufacturing PMI reading broke through the 60 mark, rising from 59.1 to 60.8, defying expectations for a slip to 58.7. It is the highest reading since 2004 and indicates ongoing strength in the economy. However, some of this optimism was muted by the contraction in durable goods sales from 2.8% month on month (mom) in December to -3.7% in January, worse than the -2.0% expected and largely owing to a fall in core capital goods.

China also had some disappointing data with the official composite PMI reading slipping from 54.6 to 52.9. This was driven by surprise weakness in both the manufacturing and non-manufacturing components. But the private Caixin Manufacturing PMI measure, which generally favours slightly smaller companies than the official index, rose from 51.5 to 51.6 (51.3 expected).

Last week’s other events

• The Eurozone economic confidence measure slipped from 114.7 to 114.1 (114.0 expected), with industrial confidence falling, but services confidence remaining more robust. Unemployment fell 0.1% to 8.6%, in line with expectations, while the Producer Price Index (factory gate pricing) fell from 2.2% to 1.5% (1.6% was expected)
• US Personal Income increased 0.4% mom in January, unchanged from December and ahead of the 0.3% forecast. Personal Spending fell from 0.4% to 0.2% mom growth, as expected. The Conference Board Consumer Confidence survey index rose from 125.4 to 130.8 (126.5 was expected), the highest reading since November 2000
• Japanese industrial production growth slipped from 4.4% to 2.7% yoy, well below forecasts for 5.3%. Retail Sales slowed more than expected, from 3.6% to 1.6% yoy (2.4% expected)
• In the UK, net consumer credit added another £1.4 billion in January, marginally less than the £1.5 billion added in December. GfK consumer confidence fell from -9 to -10 as expected, whilst the Lloyds Business Barometer slipped from 35 to 33. The Budget Responsibility Committee (BRC) shop-price index fell from -0.5% to -0.8% yoy (-0.6% expected)

The markets

Equities and commodities sold off, whilst bonds held steady. The latest Brexit developments helped sterling slip and drove a marginal rally in UK gilts.

Equities

Major equity markets weakened at the back end of the week, particularly in response to the latest US tariff plans. Europe had the toughest time with the MSCI Europe ex-UK index falling -3.4%. Japan was just behind at -2.9%. The MSCI United Kingdom index fell -2.3%, whilst the S&P 500 index of US equities fell -2.0%. Emerging markets were down -2.3% on the week (MSCI Emerging Markets).

Bonds

US 10-year Treasuries and German 10-year bunds were effectively unchanged on the week, closing at 2.86% and 0.65% respectively. The equivalent UK gilt yields were 5 basis points (bp) lower to 1.47% at the close of play on Friday.

Commodities

Commodities remained weak. Gold slipped to US$1,322.75 per ounce, Brent crude oil fell to US$64.37 per barrel and copper ended the week at US$3.10 per lb.

Currencies

Sterling was weaker versus other major currencies last week and was the main mover. Sterling finished at US$1.38, €1.12 and ¥146 on Friday.

The week ahead

It’s a busy week ahead with all eyes on the US employment report on Friday, a month on from the release which triggered a correction in US equity markets. Forecasts for the all-important average hourly earnings figure are 2.8% yoy so it will be interesting to see where this reading points, as well as any revisions to last month’s surprise reading of 2.9%. The headline non-farm payrolls rate is also expected to show 205,000 jobs added in February, from 200,000 in January. Ahead of that, there are Central Bank meetings, with the European Central Bank (ECB) meeting finishing on Thursday and the Bank of Japan meeting ending overnight Thursday into Friday. While no change in monetary policy is expected, market participants will be on the lookout for further indications of hawkish shifts in the output. On the political front, we have the annual Chinese National People’s Congress (NPC) starting this week, running until 20th March, as well as coalition talks in Italy, so plenty to keep us occupied. The daily breakdown is as follows:

Monday: early morning, Japan and China (Caixin) report Services PMIs, following by UK Services PMI (53.3 from 53.0 expected) later in the morning. Eurozone Retail Sales are also out (2.0% yoy from 1.9% expected). In the afternoon, US Non-Manufacturing PMI reading from the ISM is released (59.0 from 59.9 expected).

Tuesday: a minute after midnight, the BRC updates like-for-like sales for the UK, then in the afternoon we have US factory orders for January reported, in what is otherwise a quiet schedule.

Wednesday: Japan reports its leading and coincident economic indices early in the morning UK time, and then in the evening the US Federal Reserve releases its ‘beige book’ of anecdotal information on economic conditions.

Thursday: activity starts to ramp up towards the end of the week. As well as the ECB meeting, there is also the Japanese Economy Watchers Survey results and Chinese trade data to interrogate.

Friday: ahead of the non-farm payrolls report, there is also Chinese CPI inflation (expected at 2.5% yoy from 1.5%) and industrial production from the UK (1.9% yoy from 0.0% expected) to look forward to.