The Aussie budget deficit is widening while UK Construction is falling ... where is the good news?

Week Commencing Monday 15th December 2014

This Week in Brief

In the UK we have some intensive bank stress testing, coupled with the unemployment rate/claimant count and CPI. The unemployment figures should be bullish however there is potential for a drop in CPI given where oil prices are trading.

In the US we expect the FOMC meeting to be a non-event, with traders looking at the tone of the release rather than the contents. CPI in the US will remain flat in all likelihood; however downside risk is always a possibility.

In Europe we expect some mixed numbers from both the German and Eurozone PMI’s (especially the manufacturing PMI’s), while CPI should continue to remain flat at its current 0.3 percent. This will most likely prompt Mario Draghi to finally consider QE during the next ECB meeting.

Overriding Market Themes

We start this week in the land of Oz, where the Australian government has amended its budget deficit forecast, projecting it will balloon to AUD 40.4 billion in the year to June on the back of falling prices for key resource exports and sluggish wage growth pushing down tax revenues. Releasing the midyear budget outlook on Monday, Treasurer Joe Hockey predicted the economy would grow by 2.5 percent in 2014/15, before picking up to 3.5 percent over the next few years, while unemployment was likely to peak at 6.5 percent. Despite the change to the deficit forecast, the government noted that Australia's economy would continue to be supported by historically low interest rates, lower energy prices, and a weaker Australian dollar. The Australian economy had been seen as somewhat shielded from the global economic troubles, however to have an increasing budget deficit (especially when the majority of western governments are managing to reduce their budget deficits) is bad news indeed.

Moving to the UK, construction output declined unexpectedly in October, according to data from the Office for National Statistics on Friday. Output in the construction industry declined 2.2 percent from September, confounding expectations for a 0.7 percent rise. Both new work and repair and maintenance declined 1.7 percent and 3.1 percent, respectively in October. Private new house building fell 0.6 percent in October, new work and repair were 1.7 percent down in October and maintenance work fell by 3 percent. Public work was the only exception growing 1.1 percent. The construction sector, which contributes 6 per cent to the UK economy, is now expected to have grown by 1.6 percent in the third quarter, instead of 0.8 percent as previously estimated. The construction sector has grown robustly until recently, even though output is still about 7 percent below its pre-crisis level, but growth in recent months has slowed down. This decline is in line with a cooling in the housing market, as house price inflation slowed down in recent months, with the latest figures by Halifax showing average prices up 0.4 percent between October and November to stand at an average of £186,941.

GBP This Week

We have a busy week ahead for the UK, with some intensive bank stress testing coupled with CPI and the unemployment rate towards the end of the week. Starting with CPI, it will be interesting to see if we continue to see a downward shift as we draw towards the end of the year. With the rates currently at 1.3 percent, there is not much call for the Bank of England to act, however with downward pressures on oil prices the consensus is that the risk to inflation is heavily to the downside. Given this influence, it will be more interesting to watch the core CPI figure which excludes energy, and should this remain stable it should be reasonably bullish for Sterling.

Moving to unemployment, this month’s claimant count figure is expected to fall to -22k from -20.4 last month, so all round encouraging news for the UK employment market. The Unemployment rate is expected to hold at the current 6 percent level, however given the recent declines in the claimant count we could see it drop down to 5.9 percent.

Finally, we doubt that the stress testing will have a vast impact on market sentiment, as in general UK banks tend to be stronger than some of their European peers. That said, should we see some significant failings and/or potential of huge house price related losses we could see some Sterling weakening. As mentioned, we doubt this will be the case and should be somewhat of a non-event.

USD This Week

In the US we have the all-important FOMC meeting, however no change in policy is expected. However, the tone of the statement is likely to be the focus with the market hoping Janet Yellen will drop her “considerable time” statement with regards to the first US rate hike. Should this happen, it would further strengthen calls that the US is now the most likely contender to be the first in the G7 to raise interest rates, pushing even more buying interest onto the Dollar.

We also are watching the latest CPI figure from the US, which in general has remained relatively resilient when compared to its peers (especially Europe and Japan). With last month’s figure of 1.7 percent seen as resoundingly positive, we expect no change this month (or at worst a -0.1 percent shift to the downside).

EUR This Week

We have the German and Eurozone PMI’s out this week alongside the final CPI figure on Wednesday. Starting with the PMI’s, the most important of these should be German and Eurozone manufacturing PMI’s given their size and proximity to the 50 mark. With German manufacturing currently in contraction at 49.5 and the Eurozone figure expanding to 50.1, it will be interesting to see if either one will rise of fall above/below the 50.0 level of stagnation.

Moving to CPI, we expect the final estimate of CPI to remain flat at 0.3 percent, thereby adding the final nail in Mario Draghi’s “no to QE” coffin. We believe that this will ultimately force his hand into undertaking a QE program in the short term, putting further pressure against the Euro. That said, should we see any upside revisions in this figure expect EUR markets to react extremely positively.  


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