Total market recall

Forecasting financial markets is a seriously difficult, and some say, impossible job. While it may seem easy in retrospect, it is a very difficult task in the here and now. Case in point: one year ago, the biggest question was about the US-China trade dispute. More specifically, the main question was about the future, the potential for the trade war to escalate and/or snowball into a conflict involving more nations. Looking back, it seems easy enough to answer, but at the time, the budding drama seemed a disaster in the making. The passage of the phase one deal signalled a peak to the episode, a probable de-escalation of trade tensions and therefore we started to forecast a resolute return to growth later in the year. Stage left: enter Coronavirus and we’re back where we started.

Returning to the present, we feel a distinct sensation of déjà vu, as we opine on global growth and a remarkably familiar question; will central banks ramp up easing again due to Coronavirus-induced disruptions? The answer to that depends itself on how long the disruptions will last and how pervasive their impact might be on the global economy, both very difficult factors to gauge. If you substituted ‘Coronavirus’ with ‘trade war’, you might be hard pressed to tell which headlines are todays and which are a year old.

A few features of the backdrop changed since this question was last posed however, although the answer still seems illusive. Central bankers across the board have changed their stance on continued stimulus, increasing pressure on fiscal policy to take a meaningful role moving forward. Asset prices – driven in large part by monetary policy intervention – are much higher than a year ago despite a declining growth forecast. To put that in context, the broadest measure of the flagging European economy is the Euro Stoxx 600 which is at all-time highs.

Just this morning, we learnt that the Japanese Economy – which has become increasingly reliant on Chinese tourism – contracted by 6.3% in Q4 of 2019. This followed the introduction of a consumption tax and series of ostensibly offsetting stimulus measures. It is significant that despite a small pullback overnight, the Nikkei – a benchmark of 225 top-rated Japanese companies in Tokyo – is touching 30-year highs. In a similar vein, over the past two weeks we’ve seen poor Q4 data coming out of Germany; the EU’s largest and most China-dependent economy. Retail sales touched the worst level since 2004, Factory Orders were at the lowest level since 2014 and Industrial Production was the worst reading since 2009. Yet the German DAX equity index is at all time highs, 16% higher than a year ago. Markets are clearly pricing in further central bank assistance, which central bankers loath to provide.

Bottom line: No matter how you dice it, the uncertainty is the same, the backdrop is worse, but asset prices are higher. You could make the argument – and most do – that prices are capturing more positivity going forward, but that doesn’t seem to hold water when you view the persistent divergence in expectations and performance. It seems we are optimistic about the future economy, but just keep ratcheting up expectations despite no true sign of green growth. Quite literally, it is building castles in the sky.

The week ahead

GBP

Sterling’s index closed in the green from Monday to Thursday last week before tapering off on Friday. Cable and GBP/EUR climbed 1.5% and 2.5% respectively throughout the week, reaching highs of 1.3070 and 1.2055. The move was helped by Boris Johnson’s cabinet reshuffle after UK Chancellor Sajid Javid was replaced by ex-banker Rishi Sunak. The change has raised expectations that looser fiscal policy will support the UK economy as trade negotiations get underway throughout 2020. A busy week for UK data may provide some significant price action as Sterling has become more driven by fundamentals in recent weeks.

UK labour market data will be released on Tuesday. The quarterly average earnings index is expected to show 3.1% wage growth, slowing from 3.2% in the three-month period ending in January. Unemployment is expected to be unchanged at 3.8%.
Inflation data will be released on Wednesday morning with year-on-year CPI being the highlight. The measure is expected to show 1.7% growth in the UK’s price level, up from 1.3% in January, placing the data point closer to the Bank of England’s 2% target. Core CPI, which excludes more volatile food and energy items, is expected to show more modest growth at 1.5%.
Month-on-month retail sales for January are expected to show 0.7% growth, a significant improvement on December’s 0.6% contraction. It’s worth noting that every retail sales forecast since November has been increasingly positive, but the actual reading has come in negative.
Friday’s Purchasing Manager’s Index (PMI) will end the busy economic data week for the UK, with Manufacturing and Services PMI’s expected to read 49.7 and 53.4 respectively. This would mark a contraction in Manufacturing and expansion in the Services sectors.

USD

The US Dollar extended gains last week as Coronavirus fears heightened after China changed their diagnostic method, leading to a rapid increase in the number of confirmed cases. On a trade-weighted basis, the Dollar trades just 0.5% away from two-and-a-half year highs and has relentlessly pushed EUR/USD lower in recent weeks. The US celebrates President’s Day on Monday, so a quieter day may be expected to start the week. Various Federal Reserve members will be speaking throughout the week.

On Wednesday, year-on-year inflation data will be released with PPI expected to read 0.1% and Core PPI, which excludes more volatile food and energy prices, expected to read 0.2%. On Wednesday evening, the Federal Open Market Committee minutes from their latest meeting will be released, providing a detailed insight into the current US economic conditions.
On Friday afternoon, Manufacturing and Services PMI’s are released and are expected to show expansion at 51.5 and 53.5 respectively, although both readings are lower from January.

EUR

The Euro index extended year-to-date losses, closing last week below the 1.0850 mark against the US Dollar for the first time since May 2017. The Euro’s recent decline comes as a continuation of poor Eurozone economic data undermines earlier signs of a potential recovery in the common currency area. In recent weeks, expectations of the European Central Bank’s (ECB) monetary policy easing for 2020 have become skewed. The ECB’s last meeting accounts will be released on Thursday, providing a detailed insight on current conditions in the Eurozone.

Germany’s ZEW Economic Sentiment survey will be released on Tuesday morning with expectations being a fall in Economic sentiment from January. However, the expected number is 20, signalling optimism since the number is positive.
Friday will host a slew of Purchasing Manager’s Index (PMI) readings, with Manufacturing and Services PMI’s from Germany, France and the Eurozone. Germany’s reading, along with the Eurozone aggregate, is expected to show contraction in Manufacturing and expansion in Services. France is expected to post expansion in both sectors.