Macro insights - ECB determined but undecided while Fed rate decision will dominate and UK PM hardens Brexit stance

ECB determined but undecided while Fed rate decision will dominate and UK PM hardens Brexit stance

European Central Bank (ECB) determined but undecided.

The introductory statement of last week’s ECB meeting was dovish on several fronts. The ECB introduced an easing bias in its forward guidance of “rates at present or lower levels”, and emphasised its commitment to symmetry of above as well as below 2% in relation to the inflation target. It also set a very low trigger for action - if “the medium-term inflation outlook continues to fall short of its aim” - and tasked Eurosystem committees to look into different easing options. However, at the press conference, President Mario Draghi was less clearly dovish than the introductory statement suggested. In particular, while President Draghi reiterated his determination to act, the Governing Council appeared undecided on which tools to use, with no consensus beyond a rate cut in September. Our baseline foresees a 10 basis point cut in September coupled with tiering. We now see a higher probability that the ECB will restart quantitative easing, but more likely in a non-meaningful way – for example not necessarily changing the issue/er limits. Regarding changes to the forward guidance, moving away from a date-contingent guidance in favour of an explicit state-contingent would be the most useful tool to restore inflation expectations, but September might be too early for that. This week attention will focus on preliminary second quarter (Q2) GDP numbers for the euro area - we expect 0.16% quarter-on-quarter (qoq) - whilst for France (we expect 0.3% qoq), Italy (0% qoq) and Spain (0.6% qoq). German Q2 GDP will be released on 14 August, and we expect flat growth with downside risk. The latest German activity data, the July flash Purchasing Managers’ Index (PMI) and Ifo business survey, signal that the manufacturing downturn is accelerating at the beginning of Q3, adding risks that the largest euro area economy might be heading to recession. For now, we expect growth of around 0.1/0.2% qoq in the second half of 2019.

The US Federal Reserve meeting will dominate US and international proceedings this week, despite this being just one of several developments of note.

Last week saw US Q2 annualised GDP growth of 2.1%, a little in advance of our expectations for 1.6%. This was driven by strong consumption growth of 4.3%, ahead of our forecast for 3.8%. The erratic boost to Q1 unwound in line with our expectations, although we were surprised at the softness in both export and import growth. Separately, Congress and the White House agreed to a debt ceiling extension until 2021 and lifted spending caps, adding in excess of $300bn over the coming two years. Both reduce the likelihood of another fiscal blow-up around end-September or December. On Wednesday the Fed will react to the latest in a string of reassuring data and reduced risks including the resumed trade talks and reduced fiscal risks. Although we fully expect the Fed to ease on Wednesday, we expect Fed Chair Jerome Powell to cut rates by 0.25% - defying some expectation for a larger 0.50% cut - and to focus on the relatively positive recent economic data. This should serve to deliver a “hawkish cut” as the Fed begins to gradually rein in expectations for a string of rate cuts over the coming quarters. We maintain our forecast that the Fed will cut rates twice this year, for now considering September as the next most likely easing – but with some risks that this will be deferred until later in the year. Much depends on a continuation of more positive market sentiment. Trade talks underway in China this week will be key. These look like long-term negotiations with ample risks, but we are hopeful of a modestly positive tone emerging across this week.

Boris Johnson’s ascension to UK Prime Minister last week saw a hardening of the pro-Brexit stance.

PM Johnson’s initial communications to the European Union insisted on the re-opening of the Withdrawal Agreement and scrapping of the Irish backstop. Progress on this basis looks difficult. While we see this as defining the terrain on which a domestic general election will be fought, currency markets have focused on the prospects of a no-deal Brexit, which has weighed further on sterling. The Bank of England (BoE) presents its latest Inflation Report and interest rate decision on Thursday. BoE policy looks straightforward with a deterioration in the global outlook and rising Brexit risks both arguing for policy to remain on hold. However, the BoE outlook will be difficult to interpret as its central case “smooth transition” Brexit scenario will be increasingly questioned – and the use of implied market rates, that explicitly focus on rate cuts, will exaggerate usual growth and inflation forecasts. We continue to see the BoE on hold for the near term. However, we recognise domestic inflation pressures that are likely to prevent a rate cut and see the next move as a hike, barring a no-deal Brexit or synchronised global slowdown from here.          

Second quarter earnings delivery continues to positively surprise.

Close to 45% of S&P 500 companies have now reported Q2 numbers, 43% in Europe and only 20% in Japan. Results point to a positive earnings surprise across the board, following a significant downward revision in expectations going into the season. Top-line growth is resilient at 4.7% for the US and 2.2% for Europe, with around 60% of companies beating sales estimates in both regions. In the US, earnings are positively surprising by 5.3%, with 78% of companies beating their bottom-line estimates. Earnings growth is running at 4.2% so far with profit margins remaining flat on aggregate. Although management guidance appears intact, companies have increasingly been flagging negative trends in China following the 25% tariff hike, mostly concentrated in cyclical sectors. In Europe, we are now almost halfway through the Q2 earnings season. Reported earnings have topped consensus by 5% with growth is coming in at -3% year on year. Defensive sector companies’ earnings deliveries have generally been stronger, while cyclicals have lagged. Overall, post-reporting stock price reactions have been favourable with earnings misses not being penalised as much, while beats are being rewarded slightly more than average.


Upcoming events

US: US and China trade talks, Personal Consumption Expenditure price index (Tuesday), ADP employment change, Federal Open Market Committee announcement (Wednesday), ISM manufacturing index (Thursday), non-farm payrolls (Friday)

Euro area: Euro area business and consumer confidence, preliminary German Harmonised Index of Consumer Prices, preliminary French GDP (Tuesday), Euro area preliminary flash GDP estimate, Euro area Consumer Price Index flash estimate, Euro area and German unemployment, Italy and Spain preliminary GDP (Wednesday), Euro area, German, France, Italy and Spain manufacturing PMI (Thursday)

UK: GfK consumer confidence (Wednesday), manufacturing PMI, BoE Monetary Policy Committee decision and Inflation Report (Thursday)

Japan: Bank of Japan interest rate announcement (Tuesday)

China: Official manufacturing PMI (Wednesday), Caixin manufacturing PMI (Thursday)

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