Macro insights

US economic data underlines case for rate cut, China recovery not yet on solid footing

Last week was an important one for US monetary policy.

Federal Reserve Chair Jerome Powell gave testimony to Congress where he effectively endorsed market expectations for an easing in monetary policy in July. We adjusted our view to now expect a 0.25% rate cut in July, followed by a second in September, rather than in September and December. The Fed, as well as endorsing expectations and reacting to downside risks to the economic outlook, likely also considers that faster easing may dampen the need for the ultimate scale of that easing. However, market expectations have adjusted to see more chance – now nearly 20% - of a 50-basis-point cut. At the same time, economic data began to conform to the Fed’s outlook – ‘core’ Consumer Price Index (CPI) inflation figures edged higher to 2.1% and Producer Price Index (PPI) inflation data on Friday suggested a chance that ‘core’ Personal Consumption Expenditure inflation could creep higher to 1.7% in June – providing some evidence of the transitory softness of inflation. The coming week will see June’s retail sales released. Consumer data has been solid and we forecast quarterly growth of 3.6% annualised in the second quarter (Q2) – but will watch Tuesday’s release. Nevertheless, we forecast a subdued 1.6% growth for US Q2 GDP as a whole. Business investment and the manufacturing sector has driven this weakness. Empire State and Philadelphia Fed surveys for July will show whether avoidance of further trade escalation has improved sentiment. Solid inflation numbers helped two-year yields hold early-June levels, despite the Fed’s signal of easier policy. Any signs of improved business sentiment could further chip away at expectations for the scale of Fed easing currently priced. The coming weeks will also see focus sharpen on US budget issues and the debt ceiling limit, with hopes that this latter topic will be addressed before Congress breaks for the summer.    

In the UK, the result of the Tories’ leadership contest due next week will continue to attract focus.

However, economic releases have also captured attention. Last week, monthly output data suggested the UK would post its first quarterly contraction since 2012 and we lowered our forecast to -0.1% (from 0%). Many commentators immediately warned of recession - however, we see Q2’s drop as an unwind of Q1’s strong 0.5% inventory-and-trade driven rise. We forecast a return to growth in Q3, albeit at a subdued 0.3/0.2% pace, which we now think will deliver growth of just 1.2% for 2019 (from 1.4%). The coming week sees reports on the labour market, inflation and retail sales for June. We consider the labour market to be the most important for the Bank of England (BoE)’s outlook. That said, weak domestic and international growth prospects have gradually eroded the BoE’s optimistic and hawkish commentary from May’s Inflation Report. The next Report due on 1 August promises to be a more sombre affair.

China: Recovery not yet on solid footing.

Another end-of-the-quarter rebound in activity helped to keep Q2 GDP growth in line with the market consensus at 6.2%. However, there are many questions regarding the sustainability of this rebound, particularly in light of the ongoing US/China trade disputes, pessimism among businesses and “prudent” policy operations from Beijing. We find it difficult to believe that the resilience of the economy has improved so much that it can rise above all these near-term challenges without additional policy supports. Learning from past mistakes of withdrawing stimulus prematurely, we think Beijing will opt to keep existing stimulus in place for longer and stand ready to ease more, should growth falter again. With extra vigilance against downside risks ahead of China’s 70th anniversary, we believe Beijing will work hard to keep growth above 6% in H2.

US earnings reports to pick up with banks this week.

The Q2 earnings season has kicked off in the US with around 20 of the S&P 500 having reported so far. Initial numbers look encouraging with healthy earnings beating expectations. Close to 60% of the companies that have reported have positively surprised on their top and bottom line estimates, with an aggregate earnings surprise of 5.3%. Overall, earnings growth is running at -14% year-on-year (yoy), dragged down by the technology sector. On aggregate, consensus estimates a 2% contraction in earnings per share year yoy this season. Our indicators suggest a slight positive surprise with overall growth coming in close to flat for the season. There is a considerable risk of disappointing management guidance given the range of macro and policy uncertainty. Close to a quarter of S&P 500 earnings are expected to be released this week; the markets’ focus should be on reports from the big financial institutions including Citigroup, Charles Schwab, Goldman Sachs, J.P. Morgan Chase, Wells Fargo, Bank of America, Morgan Stanley and American Express. Other notable earrings releases include Johnson & Johnson, IBM, Microsoft and United Health Group.

Upcoming events

US: Speech by John Williams, CEO of the Federal Reserve Bank of New York (Monday), retail sales, industrial production, Federal Reserve Chair Powell speech (Tuesday), building permits (Wednesday), Philadelphia Fed Manufacturing Index (Thursday), Michigan consumer sentiment preliminary (Friday)

Euro Area: Italian CPI, ZEW Survey economic sentiment (Monday), speech by European Central Bank Executive Board Member Benoît Coeuré, Euro Area CPI, speech by German Bundesbank President Jens Weidmann (Wednesday), PPI (Friday)

UK: Average earnings excluding bonus, speech by BoE Governor Mark Carney (Tuesday), Retail Price Index, PPI, CPI (Wednesday), retail sales (Thursday), public sector net borrowing (Friday)

China: GDP, industrial production, retail sales, National Bureau of Statistics press conference (Monday)

Japan: Trade balance (Wednesday), CPI, foreign investment in Japan stocks, foreign bond investment (Thursday)

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