Markets sigh relief as UK election throws up a majority!
Week Commencing Monday 11th May 2015
This Week in Brief
In the UK we should see a return to the fundamentals following last week’s general election. In terms of data we will be watching the Bank of England on Monday, followed by the inflation report on Wednesday. Claimant count and unemployment should be broadly positive and Sterling should be in line for a decent week as market continue to ride last week’s bull-surge.
In the US we have a busy week, with all eyes likely to focus on the UoM on Friday. Retail Sales is set to increase by 0.3 percent on the month, while the UoM should see some continued gains given continue low fuel costs and continued improvement with US fundamental economic data.
In Europe, most eyes will concentrate on the Eurogroup meeting on Monday and see if there is any agreement between the Greek and the EU on further debt restructuring. This is unlikely so we expect EUR weakness to be the dominant theme for the week. German GDP is also due out (along with French and EZ), where we expect to see 0.7 percent growth on the quarter and a 0.5 percent growth for the EZ as a whole.
Overriding Market Themes
This week’s news will be dominated by the UK election and how it will impact markets moving forward. With this in mind, let’s get China out of the way! China’s central bank cut interests rates for a third time in six months last week, as it intensifies up support for an economy grappling with a debt bubble and property price slump. The People’s Bank of China reduced the one year lending rate by 25 basis points to 5.1 percent, while also cutting the one year deposit rate by the same amount to 2.25 percent. This is a bid to curb banks holding assets on their balance sheets (as they will not receive less of a return), and instead encourage additional lending within the real economy (as borrowers can access cheaper capital). This is the latest in a string of at least 30 other countries in the developing world that have chosen to loosen monetary policy this year. It also goes a long way in demonstrating the divergence between the world’s two biggest economies (and potentially with old Blighty herself!), with analysts forecasting the US Federal Reserve will lift borrowing costs later this year for the first time since 2006. China’s meteoric rise is certainly not without problems, and this is further indication that China faces some serious challenges over the coming decades.
In non-election news for the UK, the all-important UK service sector hit an 8 month high last week, potentially allaying fears the economy is slowing after the release of some very disappointing first quarter GDP figures. The MArkit/CIPS index rose for a second month in a two to 59.5, up from 58.9. The move was primarily driven by a rise in new business received by service sector firms, which interestingly has grown for the 28th consecutive month in a row. Market seem to believe that this news indicates that last quarter’s 0.3 percent GDP reading was probably a blip, and second quarter GDP should show some robust growth momentum.
Moving to the general election, the Conservative party managed to win enough seats via the current first-past-the-post system to form a majority government, albeit by a rather slim majority. That said, this victory for David Cameron is quite frankly remarkable, given the opinion polling conducted before Thursday ballot. Upon further analysis, it appears that undecided voters picked Cameron’s party for a number of reasons, including scepticism of Labours economic record, scaremongering surrounding the potential of a Labour/SNP pact and Labours general drift to the left. This is, quite frankly, a total disaster for Labour and the first time in my memory that an incumbent government has both increased seats and vote share. The Liberal Democrats were also all but pulverised, with Nick Clegg the only Cabinet member of the coalition to survive. Their previous 50+ seats were reduced to a measly 8 seats and losing their 3rd party status to the SNP.
UKIP were incredibly successful, despite the fact they only “retained” one seat in the house. In terms of the vote share they achieve the third largest share of the popular vote, and can be considered the defacto protest party. Although obviously disappointing for Nigel Farage, I suspect that this is not the last we have heard of him and 2020 will likely see some significant gains for this party.
The SNP joined the Conservatives as the real winners of the night, winning all but 3 Scottish seats in the house. This will be the interesting dynamic in the coming years, especially as David Cameron has the majority to inforce his agenda without the need to even recognise SNP concerns. Either way, markets will now focus on the performance of the economy (given the perception that the Tory’s are the market focused party) and on potential Cameron/EU negotiations on British membership. I suspect a more amenable reception by EU leaders now that Cameron has a majority, so it will be interesting to see how far they go to keep the UK in the union (especially given the current risk of a Greek exit). I imagine the price exacted by David Cameron on continue UK membership will be high.
GBP This Week
With the recent uncertainty surrounding the 2015 UK General Election having cleared, GBP assets are well supported and we have seen a significant drop in short term GBP volatility. As mentioned above, contrary to pre-election polling the election resulted in a Conservative majority government. GBP rallied on the back of the news and near-term GBP implied volatility has declined markedly following the outcome, which was perceived as one of the most favourable outcomes for FX markets. As the Conservatives possess the most aggressive fiscal tightening agenda, we expect this to increase the pace of Bank of England IR normalisation, thereby potentially boosting medium term Sterling outlook. That said, relative Fed/BoE monetary policy will without doubt continue to put extra downward pressure on GBP/USD.
In terms of data, we have a somewhat busy week ahead as the markets return to fundamentals. GBP strength will be tested by the Bank of England inflation report on Wednesday, following the May rate decision on Monday. While the Bank of England is expected to leave policy unchanged on Monday, the inflation report may see some downside pressure on short term inflation levels, and potentially see some downside revisions on Q2 GDP. Also, no member is likely to vote for a rate hike this time around, and given current conditions we are starting to push back our estimates of an increase in base rate until at least Q2 2016.
Moving to March Industrial Production, we expect to see a 0.1 percent increase in the figure versus a flat market expectation. Manufacturing production is also expected to increase by 0.3 percent on the month. In terms of employment, we expect the March unemployment rate to drop to 5.5 percent, while the pace of declining jobless claims is likely to slow to circa 15k.
USD This Week
We have a busy week ahead for the Greenback, however this week’s data set should receive mixed reviews. We start with retail sales for April which is expected to increase slightly on the month by 0.3 percent versus an 0.9 percent expectation. We also, along with the market, are looking for a rebound in the May Empire manufacturing index from -1.2 to 5.1. On industrial production, we expect the print to remain moderately unchanged in April following last month’s incredibly disappointing print of -0.6 percent. Finally, and perhaps most importantly, we are looking for the University of Michigan index of consumer confidence to have increased to 96.5 from 95.9 given the swath of recent bullish economic news and continued depression of fuel prices.
EUR This Week
In Europe we have a somewhat quitter week ahead, with the Eurogroup meeting on Monday almost entirely dedicated to the ongoing Greek situation. Finance ministers will review the progress of current EU/Greek negotiations, however we doubt they will reach any consensus that would unlock the remaining EUR 7.2 billion to the Greek government. Data wise we will only concentrate on German GDP this week, which we forecast to have risen by 0.7 percent on the quarter. We also have French GDP which is expected to accelerate to 0.4 percent while Euroarea GDP is likely to increase to 0.5 percent. All in all, these are reasonably strong numbers, however with QE and Greece we expect very little sentiment to support the EUR this week.