Markets ended last week on a positive note, with equities making new highs and bond yields nudging higher. The GBP was the worst performing currency as markets scaled up BoE easing expectations after a dire retail sales report. A stronger USD on Friday helped push the NZD down to 0.6615. The next 24 hours should be very quiet, with Wellington Anniversary Day taking place and the US closed for Martin Luther King Day tonight.
It’s been a very good start to the year for risk assets. The S&P500 added another 0.4% on Friday, bringing its year-to-date return to 3.3% while the Eurostoxx 600 increased 1%, leaving it 2.1% higher so far this year. Both indices are at record highs. US and European investment-grade corporate credit spreads also tightened last week, leaving them at their lowest levels since the start of 2018 (and near post-GFC lows). High yield credit spreads are also near post-GFC lows, reflecting both a benign economic outlook and an intense search for yield, with investors looking for alternatives to low government bond yields.
Market sentiment was supported by a batch of strong Chinese activity data on Friday. Industrial production was well above expectations at 6.9 y/y% (against 5.9 y/y% consensus and 6.2% previously) while retail sales and fixed asset investment were also stronger-than-expected. Chinese GDP increased 6% y/y in Q4, in-line with expectations. Recent data confirm Chinese growth stabilised in the latter part of 2019, with momentum appearing to pick up towards the end of the year, as past easing measures by the Chinese authorities gain traction. Looking ahead, the recently agreed Phase-One trade deal between the US and China should help reduce downside risks to the Chinese and global economies. On Friday, the CNY closed at its strongest level since early-July (USD/CNY below 6.86).
US housing data also continued its strong run, with housing starts beating expectations significantly on Friday night. A 30% jump in the volatile multi-family (i.e. apartment) category, to a 33-year high accounted for a large part of the surprise, but single-family starts were still strong too, up 11%. The backdrop for the US housing market remains positive, given the ultra-tight labour market, sharp decline in US mortgage rates last year, and shortage of inventory (following years of underbuilding in the aftermath of the housing market crash). The University of Michigan consumer confidence index remained near its cycle highs, suggestive of a still-strong US consumer.
The US yield curve steepened after the US Treasury announced that it would reintroduce issuance of 20-year bonds in the first half of the year. The front-end of the US curve was unchanged while the 10-year yield rose 2bps, to 1.82%, and existing bonds in the 20-year sector rose 4bps. The Treasury’s decision comes against a backdrop of a large and growing US budget deficit, which is expected to exceed $1 trillion this fiscal year. The Treasury decided against introducing ultra-long bonds, which should quell speculation about the potential for new 50 or 100 year bonds.
Trump on Friday nominated Judy Shelton and Christopher Shelton to fill two vacant seats on the Federal Reserve board. Waller is research direction at the St Louis Fed, which is headed up by the very dovish James Bullard. Shelton has advised Trump on economic policy. She railed against low interest rates after the GFC and has previously advocated a return to the gold standard, but seems to have had a change of heart since Trump took the Presidency and now favours lower rates. The Senate will need to confirm both nominees, with Shelton likely to be much more contentious. Trump will get to nominate the next Fed Chair next year, if he is re-elected, and hasn’t been shy about his wish for a more dovish Fed.
A dire UK retail sales report on Friday added to expectations the BoE would cut rates at its meeting later this month and weighed on the GBP. UK retail sales fell 0.8% in December, against expectations for a 0.8% rise, and fell 1% in Q4 as whole. The market bumped up its probability of a rate cut later this month to 70% and it now prices a cumulative 1.3 rate cuts by year-end. The market expects that the dreadful run of recent UK data, including the big downside surprise to CPI earlier in the week, will persuade more MPC members to join Saunders and Haskel, who voted for a rate cut at the last meeting. UK PMI data due on Friday could yet be influential to the decision, as it will be the first clean reading since the election last month. The GBP was the worst performing currency on Friday, falling 0.5% to just above 1.30.
The weakness in the GBP spilled over into EUR, which was down 0.4% to near its lowest levels of the year. The Bloomberg dollar index was up 0.2% on Friday.
Against a stronger USD backdrop, the NZD drifted lower through most of the Friday night session, ending the week around 0.6615 (-0.35%). The strengthening in the CNY again had little flow-through to the NZD and the close relationship between the two currencies may be starting to wane now the US-China trade war has become less of a market driver.
The NZ PMI released on Friday was a disappointment, with the index slipping back below the 50 mark, indicating that the manufacturing sector was again in contraction. New orders fell back to 51, well below its long-term average, while employment was around 50. The PMI data was shrugged off by the rates market, with swap rates lifting by 1 to 3bps in a curve steepening move on Friday.
The services equivalent of the PMI (the PSI) is released on Tuesday but the key release this week is CPI which comes out on Friday. We expect headline CPI to increase 0.4% in Q4 (1.8 y/y%) although with upside risks (the ANZ monthly inflation gauge suggests that non-tradables inflation could be 0.2% stronger than we pick). The RBNZ forecasted a 0.2% rise in headline CPI for Q4 (1.6 y/y%).
It will be very quiet over the next 24 hours with today being Wellington Anniversary Day and the US market closed tonight for Martin Luther King Day. But there is plenty to focus on over the remainder of the week. The Australian employment report is on Thuesday and our NAB colleagues look for the unemployment rate to tick up to 5.3% (consensus is 5.2%). US corporate earnings season continues, with Netflix the first of the big tech names to report on Tuesday. And PMI data released on Friday will give a fresh read on the growth pulse in Europe and the UK. The ECB also meets this week although no policy changes are expected.