Risk assets had a strong week – weekly update 18 March

A look back over macroeconomic and market events for the week ending 15 March 2019. Risk assets had a strong week, with equities rallying and the latest Brexit developments boosting sterling. Broader economic data continue to be mixed, however. Aside from political developments in Europe, we have a couple of Central bank meetings and a run of UK economic data to look forward to this week.

Market expectations for a softer flavour of Brexit

Following a chaotic series of Brexit-related developments, market expectations for a softer flavour of Brexit boosted sterling last week. Despite last-minute agreements from Brussels, Theresa May’s second attempt to get her deal passed failed after the attorney general left his legal interpretation unchanged. With Parliament agreeing an unexpectedly reinforced rejection of No-Deal, the Government is set to request an extension to Article 50 and just about retains nominal control of the process.

The nature of the extension will no doubt be the focus of this week, as the Prime Minister may well bring her deal back for a third attempt, hoping the threat of a long extension brings more MPs to her cause, while the EU meeting at the end of the week will likely be used to debate whatever extension option is requested. While there has been a lot of news flow and added volatility to the currency, Brexit developments currently have relatively little impact on our long-term investment strategy which, over that time frame, is much more impacted by developments around monetary policy, fiscal policy and global trade than by Brexit.

As you would hopefully expect from a diversified and risk-controlled investment strategy, we look to avoid taking significant gambles on binary events such as Brexit, and instead focus on building a strategy that we think will add value over the long-term regardless of the outcome of isolated and fairly unknowable events. However, we will continue to monitor developments and adjust the strategy should any of our fundamental assumptions change.

Data out of the US continue to be mixed

In what is a continuing theme, data out of the US continue to be mixed. The keenly watched Retail Sales print on Monday showed a bigger-than-expected bounce, with the control group returning 1.1% month on month (mom and significantly ahead of the 0.6% expected. However, the sting in the tail was that the previous shock reading was revised down even further, from -1.7% to -2.3%. The recovery probably means we can mark that reading as anomalous, but it certainly doesn’t help some of the nervous sentiment in the market.

CPI inflation dipped from 1.6% to 1.5% year on year (yoy, no change was expected) while the more policy-sensitive core rate dipped from 2.2% to 2.1% (again, no change was expected). In terms of manufacturing activity, the January Durable Goods figures beat expectations, slowing from 1.3% to 0.4% mom, defying predictions of a slip to -0.4%. But yet again the positive news was offset by disappointment in the Industrial Production reading which recovered from a -0.4% mom fall in January to 0.1% growth in February, but this was short of the 0.4% expected.

Further downgrades in economic forecasts

There were further downgrades to economic forecasts. In the UK, the Chancellor of the Exchequer reported the latest figures from the Office for Budget Responsibility (OBR), which showed GDP forecasts for this year cut from the 1.6% forecast in November to 1.2%. The Bank of Japan also joined in the downward revisions, trimming its inflation forecast from a range of 1.5-1.7% to 1.0-1.3% for this year, but left monetary policy unchanged. None of this came as much of a shock, and aligns these institutions with the mainstream. Indeed, the OBR actually gave some encouraging news for the UK, in that the Government will have achieved a primarily fiscal surplus (i.e. before interest payments) this year, for the first time since 2001-2, potentially providing some further fiscal headroom in the future.

Last week’s other events

• The latest data releases from China were also mixed, based on the year-to-date readings to February. Industrial Production growth disappointed, falling more than expected from 6.2% yoy to 5.3% (5.6% was expected), Retail Sales slowed from 9.0% to 8.2%, which was in-line with expectations, while Fixed Asset Investment picked up from 5.9% to 6.1% (also as expected)
• UK Industrial Production was unchanged at -0.9% yoy, but was ahead of the -1.3% deterioration that had been forecast. Manufacturing Production improved more than expected from -2.1% to -1.1% (-1.9% was forecast)
• Eurozone Industrial Production was still shrinking, but was nonetheless much improved from the previous reading of -4.2% to -1.1% (-2.1%)

The markets

Risk was back in the driving seat last week with strong gains across equity markets while sterling benefitted from the significant softening to the Brexit outlook, however sovereign bonds were little moved overall.

One-month performance of major asset classes in sterling terms

Equities

It was a great week for equities last week, led by the US, rising 2.9% on the week. Europe (ex-UK) returned 2.7% while the UK was the relative laggard, returning 1.9%. Japanese equities gained 2.0% whilst the Emerging Markets index returned 2.3% (indices are MSCI measures, in local currency, total return).

Bonds

Despite the risk rally, core sovereign bond yields were actually little moved. 10-year US Treasury yields actually fell 4 basis points (bps) to 2.59%. In the UK, 10-year gilts rose 2 bps to finish at 1.21% and the equivalent German bund yields were 2 bps higher to 0.08%.

Commodities

Oil was marginally stronger on the week, rising to US$67.16 per barrel by Friday, while gold broke through the US$1300 mark, closing the week at US$1,302 per ounce. Copper was barely moved on the week, closing at US$2.90 per lb.

Currencies

Sterling was significantly stronger on the week as the Brexit outlook notably softened gaining 2.1% against the US dollar as both the greenback and the Japanese yen weakened into the risk-on rally. Sterling closed on Friday at US$1.33, €1.17 and ¥148.

The week ahead

Brexit is again likely to be the focus this week with the last EU summit before the first Brexit deadline starting on Thursday where leaders will need to decide the next steps – presumably some level of extension, but that depends on the 11th hour negotiations in the UK. On the economic calendar, the highlights are likely to be the US Federal Reserve meeting concluding Wednesday, and the Bank of England meeting finishing on Thursday – no changes are expected so the statements and press conferences will be the points to watch. There will also be a number of interesting data points from the UK with Tuesday offering up the latest UK labour market data (average weekly earnings are forecast to have dipped from 3.4% to 3.2% yoy). Wednesday supplies UK CPI inflation data for February (no change at 1.8% expected), while on Thursday we have UK Retail Sales due out (3.3% from 4.2% yoy expected). With the economic data potentially turning upwards, the forward-looking PMI survey data for Japan, Europe and the US on Friday will also be of interest, details below. The daily breakdown is as follows:

Monday: UK House Price data are released a minute after midnight with Eurozone trade data out later in the morning in what is otherwise a quiet start to the week.

Tuesday: As the UK waits to see whether the Withdrawal Agreement is put forward for a third vote, the UK will also have the labour data to look forward to. As well as the average weekly earnings covered above, the unemployment data (no change at 4.0% expected) and weekly earnings excluding bonus (no change at 3.4% expected) figures are also likely to be of interest. Later in the morning, the ZEW survey results of Eurozone business sentiment are reported.

Wednesday: UK inflation in the morning and the latest Federal Reserve meeting are the only events of note mid-week, both of which are covered above.

Thursday: The highlights of UK Retail Sales and the Bank of England monetary policy meeting are covered above. Thursday also gives us the Philadelphia Federal Reserve's business outlook and the US Conference Board Leading index. Later in the afternoon, Eurozone Consumer Confidence is reporter and then just before midnight Japan releases the latest CPI inflation figures (0.3% from 0.2% yoy expected).

Friday: A raft of PMI data are due out Friday, starting with Japan, where Manufacturing PMI is released shortly after midnight. Later in the morning, Eurozone Manufacturing PMI is forecast to remain in contractionary territory, but with a marginal improvement from 49.3 to 49.5 while Services PMI is expected at 52.7 from 52.8. In the afternoon, US Manufacturing PMI is expected at 53.6 from 53.0 whilst Services is expected to have dipped from 56.0 to 55.8 (both Markit readings).