Macro insights

US employment data rebounds, Greece hits the polls while trade tensions emerge between Japan and South Korea

Last week’s US employment report eased concerns over a potentially imminent interruption to jobs’ growth, with June’s headline 224,000 expansion, unwinding May’s disappointing numbers.

However, markets remain concerned that with trade tensions easing and risk assets continuing to perform e.g. the S&P 500’s fresh high last week, that the Federal Reserve is unlikely to deliver the near five cuts priced-in by markets over the coming 12-months. Risk assets have retraced a little as market expectations wavered.

We agree and have argued that Fed easing is likely to be more measured – we forecast two cuts - unless fresh economic headwinds beset the US or global economy. That said, the Fed faces a difficult task in weaning markets from their expectations for five cuts, without causing a sharp tightening in financial conditions – a potential economic shock, in its own right. This week sees a new labour (JOLTS), and business surveys (the NFIB small business survey) published as well as and June’s CPI inflation numbers.

More importantly, we will get new information from the Fed, with Chair Jerome Powell expected before Congress, for his semi-annual monetary policy address on Wednesday and Thursday. Additionally, the minutes from the latest Federal Open Market Committee meeting arrive on Wednesday. These will definitively set the course for the future of monetary policy.

However, the weight of expectation for a July easing (Bloomberg suggesting more than 95% expected) may be too overwhelming for the Fed to risk a disappointment at this stage. If this is the case, it may ease policy, by 0.25% basis points in July but perhaps send a relatively hawkish message to encourage reduced expectations for future meetings. Indeed, the Fed stands a greater chance of managing expectations and financial conditions against a background of more supportive economic data – perhaps suggesting front-loaded easier monetary policy. 

German industrial production edged up by 0.3 % month-on-month in May after its 2% April decline. This echoed depressed manufacturing sentiment and poor factory orders, with the latter falling by 8.6% year-on-year (yoy) in May, the steepest drop since the financial crisis.

We expect no GDP growth in the second quarter (Q2), and even see downside risks to our 0.6% yoy 2019 German growth forecast. Last week was rich in terms of political developments. For one, the Rome / Brussels negotiations made progress. The Italian government committed to a 2019 deficit of 2% of GDP, with the 0.4% of GDP savings coming from a small budget freeze and fiscal outperformance so far this year. The European Commission is therefore no longer asking for the opening of a debt-based Excessive Deficit Procedure, a decision likely to be endorsed at the 8/9 July Ecofin meeting. But we do not think it is the end of the Italian fiscal saga - the arithmetic of the 2020 budget is still very challenging and tensions are likely to flare up again in the Autumn.

In addition, the European Council proposed Christine Lagarde as the new European Central Bank president. Her expertise into the heterogeneous political and economic dynamics - key features of handling the monetary policy of the currency union is very welcome, but the absence of a technical economic background makes the replacement of Benoit Coeuré at the end of the year, very important in the shaping of “Lagarde’s ECB”. This week the ECB minutes might be worth watching and could shed light on the level of support among the Governing Council, following Mario Draghi’s speech at Sintra.

In the snap elections called by prime minister Tripras, the centre-right Conservative party of New Democracy won just under 40% of the votes and will thus be able to form a majority government with 158 out of 300 seats.

Alexis Tsipras’ Syriza party still managed 31.5%, better than expectations of a double-digit gap. Former Finance Minister Yanis Varoufakis’ new party also managed to enter the parliament by exceeding the 3% threshold. A pleasant surprise to this electoral outcome is that the neo-facist far right party Golden Dawn failed to reach the 3% threshold and is therefore excluded from the new parliament.

The new prime minister Kyriakos Mitsotakis, ran a manifesto of honesty and much needed reforms - modernisation as well as some relief from the over-taxation that resulted from the unnecessary third bailout after Syriza’s disastrous 2015 negotiation with the European Union. The challenge for Mitsotakis is to form a government of fresh, capable and motivated people who will hopefully remain unspoiled by the ills of the Greek political system. With previous New Democracy governments undoubtedly a contributor to the economic woes of Greece, the risk is that his government becomes polluted and ultimately hindered by legacy New Democracy elements, possibly yearning for the politics of the past i.e. clientelism, corruption and resistance to change.

The UK continues to be caught between two tides – a weakening global trade backdrop and Brexit.

The former weighs in the balance with global central banks considering the necessary degree of stimulus required to cope with US protectionism. However, recent manufacturing survey weakness (including June’s manufacturing PMI fall) suggest the export-focused economy is suffering alongside other international exporters. Fresh economic news on the latter is scant with markets struggling to distil fact from campaigning from the two Tory leadership contenders. Wednesday’s output data releases for May, covering manufacturing, services, construction and GDP, will help shape expectations for Q2.

After April’s release showed a retracement from the solid 0.5% Q1 GDP expansion, we lowered our Q2 GDP forecast to 0.0/0.1% from 0.2%. Subsequent changes to the composition of Q1 growth, suggests a greater downside risk to Q2 with a greater-than-considered boost from inventory during Q1. Wednesday’s data will help us judge whether Q2 GDP will escape contraction. Meanwhile, Chancellor Philip Hammond is said to be coordinating a Tory MP group looking to avoid a no- deal Brexit. If this group is successful in securing Parliamentary time to pass legislation in October, markets may grow in confidence that a worst-case Brexit scenario can be avoided.           

Trade tensions flare-up between Japan and South Korea.

Two days after the G20 meeting, the Japanese government declared a move to restrict exports of three materials - all key in making semiconductors, chips and smartphone displays, to Korea. This move was initiated in an apparent effort to raise pressure on Korea to help resolve a bilateral dispute over compensation for forced labour during WWII. In the near-term, Korean tech-giants such as Samsung and LG will likely be hit the hardest due to their dependence on Japanese products - who hold the lion’s share in the global market – and their inability to manufacture these materials. To make things worse, Korea has announced possible retaliatory measures such as limiting exports of OLED screens to hurt Japan’s electronics giants such as Sony. This is another sign that trade is being used as a possible weapon to solve political issues.


Upcoming events

US: NFIB small business optimism and JOLTS – Jobs opening (Tuesday), FOMC Minutes (Wednesday), CPI and Weekly jobless claims (Thursday), PPI (Friday)

Euro Area: ECOFIN meeting (Tuesday), French and Italian Industrial production (Wednesday), German HICP and CPI, French HICP and ECB Monetary policy account published (Thursday), EU19 Industrial production and Spanish HICP (Friday)

UK: BRC Retail Sales Monitor (Tuesday), Monthly GDP, Index of services, Industrial production, Manufacturing and Construction output and Total trade balance (Wednesday), RICS Housing Survey BoE Financial Stability report (Thursday)

China: CPI (Wednesday), Trade Balance (Friday)

Japan: Industrial Production (Friday)

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