UK Economic and Political Implications
This week, the UK saw a 2.3% CPI increase, slightly above the 2.1% forecast, and a core measure of 3.9% versus the expected 3.6%, leading to a hawkish market response and a 10 basis point rise in yields. These developments, coupled with the upcoming general election, cast doubt on the timing of rate cuts, particularly those expected in August. Disappointing retail sales underscore the tension between inflation and growth.
US Macroeconomic Outlook
The US macroeconomic scene remains pivotal, with recent FOMC minutes hinting at a possible rate hike dependent on future data. The term "various" in Fed communications created market uncertainty. FOMC member Waller suggested a need for several months of positive inflation data before significant policy changes, pushing potential shifts to September. Optimism from PMI data contrasts with the downward trend in ISM data.
European Economic Developments
In the Eurozone, Germany takes center stage with the upcoming German IFO report, influenced by positive signs from China. ECB Chief Economist Philip Lane’s comments on the June rate cut and future rate paths will be critical. The Eurozone CPI preliminary print for May, set for Friday, is essential for future ECB rate decisions. Higher-than-expected wage settlements suggest markets are pricing in a June rate hike, with significant implications for currency markets.
Transcript
Matt Jones
Welcome to "The Long & Short of the Week Ahead", a production of Eurizon SLJ Capital that takes a look at the macro-economic themes of the week ahead and has been recorded for professional investors.
My name is Matt, Head of Distribution for Eurizon SLJ Capital, and I'm joined by Neil Staines, Senior Portfolio Manager.
Welcome back, Neil. It's great to have you here with us again.
Neil Staines
Thank you very much Matt. It's great to be here.
Matt Jones
Now with a shock announcement. I think we'll start with the UK this week. Because obviously we've had a lot of data over the course of the week and and also a big political announcement, not quite as big as my announcement. But how are we looking at the economic and political implications for UK markets next week?
Neil Staines
Yeah, thanks very much, Matt.
It has been a huge week for the UK. The start of the week focus was on the CPI print, which came in at 2.3%. Fantastic news from a consumer perspective and a positive spin was certainly placed on that by the Prime Minister. However, it did miss expectations. So 2.3% on the headline, an expected 2.1%, and it was the core measure miss at 3.9% against an expectation of 3.6% that actually drove a hawkish market response. Yields in the UK up 10 basis points on that miss relative to expectations. That led to a pricing out of the rate cuts in June, which had prior to the announcement being 50 50. We discuss this a little bit further in this week's blog and ultimately how we draw the attention to the issues with markets focusing too much on the relative or sequential movements and not so much on the absolute level of rates after all inflation has come down from 11.1%. And then we got the general election announcement. And that casts some doubt on the August MPC meeting for the first rate cut. Essentially, that comes about as a function of the fact that if the Bank of England do not see clarity around government, if there were the case of coalition building after the general election, Or if there were an, any uncertainty about the fiscal path of the new government, then it would make it difficult for the Bank of England to cut rates, given uncertainty around their projections, going forward. Now at the same time. In the UK, we've also seen very weak retail sales data released this week and that highlights the fragility and the trade off really that we're seeing between inflation and growth in the UK. And obviously longer delays from the Bank of England, particularly if they are politically inferred delays, may mean faster cuts further down the track.
Now, next week we get mainly second tier data with a bigger focus. On bank of England policymakers and any announcements or discussions that they may have that brings further clarity around the Bank of England policy reaction function. But another big week for politics, for economics and for UK markets.
Matt Jones
Absolutely. Now in the meantime, the US continues to grab headlines in both the equity and the rates markets. How do we see the US macro picture evolving next week?
Neil Staines
Yeah. Thanks, Matt. US markets do continue to dominate the macro debate and we discuss a little further in this week's blog also, the reaction to the FOMC minutes that we saw this week. Now, essentially there was a positive or more hawkish response as the the Fed minutes highlighted that various members would consider a rate hike if the data warranted, not least because the word, the term various within the Fed lexicon, it's not clear where this fits between "a few", "many", and "a number of", in terms of the quantitative spectrum of Fed speak. Waller also this week, an important member of the FOMC, also referenced the facts. That's the Fed may need to see three or four months of further positive data on the inflation front before they can act. This kind of pushes back expectations to the somewhere around the September meeting. So slightly more hawkish.
We also got a a positive, or more hawkish reaction from markets to the PMI data this week, although we would look at that with a pinch of salt, the PMI data doesn't correlate particularly well with the ISM data, which is more of a stronger focus from our perspective, in terms of service sector and manufacturing sector activity; and the ISM itself is on a more negative trend. Next week we get US consumer confidence for May. We get the second revision of the Q1 GDP data, which is expected to drop further to just 1.2% for Q1, much, much weaker than markets had anticipated going into the first print. And we get PCE, and now, whilst this is the preferred measure from the Fed and a very important release in itself. Given the fact that we've had the CPI and the PPI, we should know all the component parts there. So the big focus is likely to be on Fed speakers, with no first tier data releases and what the implications are for the Fed policy reaction function.
Matt Jones
And what about Europe? How has the European macro economic trajectory been affected by the UK and US developments? And, what are we focused on next week?
Neil Staines
Yeah. Thanks Matt. After what has been a relatively quiet period for Eurozone data, we get a bit more focus back next week. On Monday, it's a German IFO. Germany, a specific focus in Europe. Particularly given the encouraging signs that we're seeing in China and how that impacts Germany in particular through the trade channels. Monday also sees commentary from ECB chief economists Phillip lane.
And it'll be very interesting to see, not just how he phrases expectations relative to a June rate cut, but more pertinently how those expectations are shaped for the future path of potential ECB rate cuts. On Friday, we get Eurozone CPI. That's the the preliminary print for May. And that will also be important in shaping that very significant rate path in the Eurozone. In Q1, we have had negotiated wage settlements this week at a slightly higher level than expected, a slightly higher level than the ECB will generally be comfortable with, but markets are still pricing 22 basis points for that June hike. So almost fully priced there. What will be important for markets will be the ECB signaling for the rate path beyond June, and more broadly, relative to the US and the UK rate paths going forward with significant implications for currency markets.
Matt Jones
Fantastic. Thank you for joining us once again and outlining your thoughts on the week ahead. I look forward to catching up with you again next week.
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