In yesterday’s European morning, fundamentals took precedent. The UK’s August employment report showed that the unemployment rate remained at a four-decade low of 4.0% while wages surged. UK basic pay in the three months to August rose 3.1% annually, the highest growth rate since the start of 2009. With productivity stuck around zero, wage increases are purely inflationary, and if Brexit weren’t staring the Bank of England (BoE) in the face, earnings data would add pressure on the Bank to raise UK interest rates further. Sterling immediately gained against both the US Dollar and Euro.
Then it was Germany that jolted currency markets after the ZEW survey of investor expectations sank to a four-month low, and the indicator dragged the Euro down with it. Germany has taken the brunt of the intensifying trade dispute between the US and China, made all the more difficult by a stronger EUR. German factory orders, manufacturing, and exports have suffered from softening Asian demand since the start of 2018. BMW, a flagship German carmaker, issued its first profit warning in a decade in September, citing trade conflict and price competition. Germany’s trade weakness is one reason behind our call for an orderly soft Brexit. The Eurozone powerhouse will not want to jeopardise a key market for its goods.
In the US morning yesterday, equities set the tone. Strong earnings reports from the likes of Goldman Sachs and Morgan Stanley managed to justify equities’ stretched valuations, at least for now. The result was the biggest one-day gain since March for the S&P 500, Dow Jones, and Nasdaq Composite.
We spoke previously about how the recent sell-off was more likely to be a correction than the end of the equity bull run, and the US earnings season would be key to reinstating confidence in US equities. At this juncture, equities are now cheap and there is money to put to work. Survey evidence showed fund managers began hoarding cash over recent weeks as risk sentiment soured. This sets the stage for a near-term rally in equities if risk sentiment can hold up.
The implication for currency markets was that the ‘sell US’ theme turned to ‘buy US’. The Dollar rallied in line with US equities, pushing both EUR/USD and GBP/USD lower in the Stateside session with the moves continuing overnight in Asia. Further US earning reports will be key to supporting risk sentiment and the equities.
For the day ahead, the market focus will be on the UK September Consumer Price Index (CPI) released in the European morning. The August release surprised markets with an acceleration in price pressures, despite expectations that the impact of Sterling’s past depreciation would continue to fall out of the annual calculation, pushing inflation lower. However, the surprise rise in price pressures was driven by volatile components – computer games, seasonal clothing discounts, theatre tickets, and air and sea fares all played a part. We expect UK inflation to resume its downward trend in September; however, the recent increase in energy prices means moves lower will be more gradual, and inflation is unlikely to fall below the 2.0% target until 2019.
In the US session, there is a host of US housing market data. The US October 12th MBA Mortgage Applications, September Housing Starts, and Building Permits figures will provide a guide to how the US housing market is faring with higher borrowing costs and affordability problems. Canada will publish its August Manufacturing Sales data. The typical focus on the Federal Reserve’s minutes of its latest meeting will this time be limited as the dramatic developments in global bond and equity markets since the September 26th meeting makes these minutes relatively stale. Chairman Jerome Powell’s press conference following the rate decision also means the Board’s decision-making process has now been well explained to markets. The focus will be on the Committee’s view of the inflation, which several Board members have already suggested will determine the pace of rate increases.
October’s EU Council meeting has been long hyped as the deadline for a UK-EU agreement on the Withdrawal Bill, but a standoff on the Northern Ireland backstop continues to hamper negotiations. UK Prime Minister Theresa May will deliver a speech before the working dinner on Wednesday night where the state of Brexit negotiations will be reviewed. The key thing to watch for is an announcement of an extra European Council meeting in November, which could pave the way for a final EU-UK Withdrawal Agreement if enough progress is made. With reports of dissent and resignations in Westminster over the current proposal, the goings on in London will be just as important as those in Brussels.
On the speakers’ schedule, the BoE’s John Cunliffe speaks before lawmakers. He is typically regarded as a dove, but as Deputy Governor for financial stability, his remarks may not stray to monetary policy concerns. The Fed’s Lael Brainard speaks but with the conference topic Fintech and Financial Inclusion, and with no Q&A she may not touch on monetary policy. Bundesbank President Jens Wiedmann speaks in Berlin and is sure to sound a hawkish tone. S&P 500 had its biggest one-day gain since March; Source: Bloomberg