China remains robust while India lags behind!

Week commencing Monday 2nd June 2014

This week in Short

  • In the UK we have all three PMI’s set to be released along with the Bank of England MPC announcement. We expect a mixed bag with the PMI’s, with the all-important Services expected to decline slightly on the month. We expect no movement in either rates or QE from the BoE.

  • We have CPI and the ECB from Europe this week, with markets focusing heavily on Mario Draghi’s reaction to the CPI release. We could very well see a drop in base rate from the ECB to 0.1% from the current 0.25% as Draghi struggles to combat a strong Euro and deflationary pressures.

  • In the US we have a swath of jobs reports set to be released, with the unemployment rate set to consolidate at 6.3% while non-farm payrolls should see a rise of 288k.

Overriding Market Themes

Manufacturing activity in China rose to a five-month high last month, in a sign that the sector remains robust against the backdrop of weaker economic conditions. The official PMI climbed to 50.8 in May, according to National Bureau of Statistics, China’s official statistics agency. Critically, this was above the 50 reading that divides growth from contraction, and up from 50.4 in March. It was also higher than the reading of 50.6 expected by analysts. Despite this however, the world's second largest economy has shown further signs of slowing down. The economy grew at an annualised pace of 7.4percent in the first three months of the year, following growth of 7.7percent in the final quarter of 2014. This meant that growth in the first quarter was the weakest registered expansion in just over 18 months. To try and combat this, policymakers have been trying to move China away from its over-reliance on investment and exports to drive growth and want to shift the balance towards consumption. Last week, China signalled that it could take steps to ease monetary policy to support the economy by cutting the amount of cash banks must hold in reserve.

Moving to another economic powerhouse, India's economy grew by 4.6% in the first three months of the year, well below what many consider ideal for the emerging market country. India's growth potential was once considered to be relatively in line with China, however it seems that the world's largest democracy has failed to deliver it, with its economy is just a fifth the size of its main Asian rival. Many analysts say that in order to begin to achieve stratospheric growth (as we have seen in China), India needs to simplify its tax code, encourage foreign investment and streamline agricultural production. Looks like newly elected Prime Minister Narendra Modi has got his work cut out for him!

Across the Atlantic, The US economy contracted for the first time in three years in the first quarter as it buckled under the severe winter. The Commerce Department on Thursday slashed its estimate of gross domestic product to show the economy shrank at a 1.0 percent annual rate. Not only that, but the worst performance since the first quarter of 2011 also reflected a far slower pace of inventory accumulation and a bigger than previously estimated trade deficit. Despite these disastrous figures, many believe that this was just a blimp and that the economy should return to “business as normal” in the second quarter. Bullish jobs data released on Thursday also bolstered the case for an economy on the rebound as Labour Department numbers showed state unemployment benefit claimers declined 27,000 to a seasonally adjusted 300,000 last week. Separately, contracts to buy previously owned homes rose in April for a second month, a positive sign for the troubled housing market. The reports added to data on manufacturing and hiring that have buoyed hopes of strong bounce back in growth.

 GBP This Week

We have the usual start to the month with the release of the PMI’s, followed by the Bank of England MPC meeting on Thursday. Starting with Manufacturing PMI on Monday, we expect this indicator to be tested this month, where estimates are pointing towards a moderate pullback to 57.1 from 57.3. The importance of the manufacturing sector for the UK economy largely lies in its need to diversify away from the all so dominant services sector. Therefore any sizable pullback will be likely to be noted as reasonably bearish for the UK economy, and therefore the Pound.

On Tuesday, the construction PMI figure is expected to amaze markets after three months of disappointing surveys, with a rise from 60.8 to 61.2. We then shift our focus to the all-important Services PMI on Wednesday, with analysts forecasting a reversing of fortunes with a reduced figure of 58.3 expected from last month’s 58.7. That said, we have had some rather large surprises with this indicator, so we cannot rule out a further expansion of the sector as we move towards the end of the second quarter. Given the importance of the service, accounting for around 85% GDP  in recent months, should we see an expansion expect Sterling to enjoy a bullish day.

Finally, current expectations point towards very little in the way of changes from the BoE for the time being, and therefore we expect this event to be somewhat of an anti-climax. Analysts are almost certain that interest rates and asset purchases will remain at their current levels for the foreseeable future.

USD This Week

The first of the major employment figures to be released is the ADP non-farm employment change, which is due to be released on Wednesday. We expect a relatively flat figure this month, thereby not providing markets with much direction to trade on. Also, with tapering seemingly set on a solid trajectory, we doubt that any release in this figure will be big enough to effect the FOMC decision later on this month.

Moving to Friday, Following the unprecedented 0.4% drop last month, the unemployment rate is expected to consolidate at 6.3% this time around. This should mean that non-farm payrolls should see a potential pullback from the major round of hiring last month which saw a rise of 288k employed.

EUR This Week

We have a somewhat mixed week ahead for the Eurozone, with CPI inflation data expected alongside the ECB interest rate decision on Thursday. Starting with inflation, should we see further deterioration in the inflation figure, or else even a failure to move higher, this would put further pressure on Draghi to ease interest rates later in the week. Expectations are for the figure to remain at 0.7%, which should leave some options open for Mario Draghi. However, a move in either way could majorly effect market perceptions and therefore either sell off or buy the Euro in quite a big way.

Moving to Thursdays interest rate decision, markets are expecting to see the first interest rate cut in 8 months from the European Central Bank. This comes off the back of ongoing pressures from both within the ECB and the public for Draghi to cut rates or take some sort form of action to boost the region, increase inflation and devalue the euro. We expect that he will have no choice but to make a minimal reduction in rates to around 0.1 percent from the current 0.25 percent. We would also expect that if he does nothing, traders will instead buy the Euro and we could see some reversal of its losses against Sterling during the past few months. 


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