US & China Seal The Deal; US Consumer In Focus

The latest market highlights and our views on the key developments as the phase one US-China trade deal is signed; sluggish inflation sees markets price a greater chance of the BoE cutting rates; while US retail sales and the latest ECB minutes are eyed today

Previous Day's Market Highlights

Trade - Phase One Signed

At last, after seemingly endless rounds of negotiations, and numerous tit-for-tat tariff escalations, the US and China have finally signed a 'phase one' trade deal.

The deal, signed yesterday in Washington DC by President Trump and Chinese Vice Premier Liu He, effectively acts as a ceasefire in the ongoing trade war, halting any further tariff increases, and marks the two superpowers agreeing a truce, largely through increased Chinese purchases of US exports.

These purchases make up by far the largest part of the deal, with China pledging to purchase $200bln worth of goods above the levels purchased in 2017 in an attempt by the US to narrow the trade deficit. The specifics of these purchases, which are spread across agriculture, energy, and other areas, have not been revealed, however it was agreed that market conditions - presumably price - may dictate the timing of such transactions.

The deal also made some provisions on intellectual property rights and the forced transfer of technology, however it does not mandate any changes in Chinese law, hence compliance may be questionable. Other sections of the phase one deal make theft of trade secrets a criminal offence, and take aim at the Chinese production of counterfeit goods. The agreement will come into effect 30 days after yesterday's signing ceremony.

However, for markets, focus has already shifted to the second phase of talks, which will have to cover much more complex issues - for example, state aid given to Chinese corporations.

According to President Trump, the second stage of talks will begin "very shortly", however the discussions are unlikely to be a quick or simple process. Any additional tariff rollbacks, or cancellations, will also not come into effect until after a second phase of talks has concluded.

In reaction to the signing ceremony and announcement of the deal's details, markets largely shrugged their shoulders, with the agreement having been fully priced in. The dollar ended the day around 0.15% lower against a basket of peers, while the remainder of G10 FX was rangebound for a 2nd straight day.

Elsewhere, 10 year Treasury yields dipped by around 3bps as part of a broader, global, bond rally; while US equities ended the day at record highs, with the benchmark S&P 500 adding 0.19%.

 

UK Inflation - Downside Surprise

Meanwhile, here in the UK, markets continue to price in a Bank of England rate cut as soon as the end of the month.

The doves have been further spurred on by yesterday's CPI inflation release, which showed the pace of price increases falling to a more than 3-year low in December.

The report showed headline inflation at just 1.3% YoY, and core inflation at a lacklustre 1.4% YoY; with both prints falling around 0.2% short of expectations.

 

 

However, on a note of caution, a large part of the decline in inflation is easily attributable. Firstly, the recent reduction in the Ofgem energy price cap has depressed fuel prices, thus resulting in lower inflation over the last few months. Meanwhile, looking at December specifically, the transitory effect of lower airfares contributed significantly to the decline in inflation, as the below chart shows.

Nonetheless, despite the above factors, and despite the fact that the decline in CPI seen in the last few months has been incorporated into the Bank's forecasts, markets believed that the benign pace of price increases would spur the MPC into delivering near-term stimulus.

As a result, the probability of a cut - as determined by overnight index swaps - has risen further, with markets pricing in a 60% chance of a 25bps rate cut at the end of the month.

My expectations, however, for the January MPC meeting remain unchanged, as I still don't believe that the BoE will deliver a cut this month, nor do I believe that the economy warrants additional stimulus at this time.

However, after yesterday's data miss, tomorrow's retail sales figures and next week's flash January PMIs have taken on even greater importance. Should these reports come in softer than expected, my view will likely change and tend towards a rate cut.

For sterling, the lacklustre inflation figures and increased chances of a BoE rate cut posed a relatively stiff headwind in the morning session. The pound dipped around 40 pips after the inflation figures, however pared those losses as the day went on, particularly against the dollar.

Sterling ended the day unchanged against the dollar, and 0.2% lower against the single currency.

 

Wednesday's Other Releases

Elsewhere, a number of second-tier data points were also released on Wednesday:

 

  • The latest eurozone industrial production figures showed output reaching a 3-month high last November, with production increasing by 0.2% MoM.
  • In the US, factory gate inflation remains benign, as shown by yesterday's PPI report. Headline PPI increased at just 1.3% YoY last month, while core PPI was at a subdued 1.1% YoY.
  • The Fed's latest Beige Book pointed to the US economy continuing to expand at a modest rate in December, while the near-term outlook remains favourable despite 'essentially flat' activity in the manufacturing sector.

Any Other Business

 

  • Wednesday was a busy day for US politics, with reports of the Trump Administration considering a pre-election fiscal stimulus package; as well as the House voting to transmit the Articles of Impeachment facing Trump to the Senate.
  • Oil prices fell for a 6th day out of the last 7 on Wednesday, after a build in US inventories. Both global benchmark Brent and US WTI crude ended the day 0.7% lower.

 

Currency Pairing 08:00 Today Vs 08:00 Yesterday Four-Week High Four-Week Low % Change
GBP/EUR 1.1695 1.1831 1.1628 1.72%
GBP/USD 1.3040 1.3266 1.2903 2.74%
EUR/USD 1.1150 1.1239 1.1085 1.37%
GBP/AUD 1.8885 1.9156 1.8635 2.72%
GBP/NZD 1.9665 1.9840 1.9415 2.14%
GBP/CAD 1.7010 1.7261 1.6918 1.99%

Today's Market Highlights

US Retail Sales

Today's data highlight comes from the US, in the form of the all-important December retail sales report.

Headline sales are expected to have increased for a third straight month, with a gain of 0.3% MoM expected. Meanwhile, sales excluding autos are expected to have increased by 0.5% MoM, and the control group sales measure - which feeds directly into the GDP report - is expected to have increased by 0.4% MoM.

 

 

The sales release is important for two reasons. Firstly, as mentioned many times before, consumer spending is the primary factor underpinning the ongoing economic expansion in the US, picking up the slack from an ongoing slowdown in the manufacturing sector.

As a result, any signs of softness in the sales report could threaten the longevity of the current expansion, particularly if sales begin to trend lower.

Secondly, today's report covers the crucial festive shopping season. Therefore, markets may be priced for an upside surprise, given the usual increase in sales around this time of year.

For the dollar, and the Fed, however, barring a significant downside surprise, the release shouldn't materially alter the outlook.

 

ECB Minutes

Today's other main event comes from the ECB, with minutes from the December monetary policy meeting due this lunchtime.

The meeting, which was Christine Lagarde's first as President, saw monetary policy left on hold, however investors will parse the minutes for any hints or comments on the policy outlook. Any such comments will, however, likely focus on the continued need for fiscal stimulus from eurozone governments, with the ECB's monetary policy toolkit severely depleted.

Market participants will also be on the lookout for any clues as to what the upcoming strategy review may cover, particularly whether the ECB are planning to examine changing their inflation target to a symmetrical one. As mentioned earlier in the week, such a move would likely result in the present ultra-loose policy stance remaining in place for some time.

Later on today, after the minutes have been released, ECB President Lagarde is set to make remarks in Frankfurt. Any policy remarks, however, are likely to follow a theme broadly similar to the minutes.

 

Anything Else?

  • A handful of other, lower-tier, releases are also due today, including last week's US initial jobless claims; January's Philadelphia Fed manufacturing index; and December's Canadian ADP employment report.
  • Apart from President Lagarde, today's only other central bank speaker is Fed board member Bowman, who typically takes a neutral monetary policy stance.
  • Finally, this week's bank earnings are rounded out today by Morgan Stanley, who will report before the opening bell.

Today's Economic Calendar

Time Currency Release Consensus Previous
12.30pm EUR ECB Meeting Minutes (Dec)
1.30pm USD Retail Sales (MoM - Dec) 0.3% 0.3%
1.30pm USD Retail Sales ex Autos (MoM - Dec) 0.5% 0.1%
1.30pm USD Retail Sales Control Group (MoM - Dec) 0.4% 0.1%
6.00pm EUR ECB President Lagarde Speech