US and euro area growth remain strong in Q1:2018, with the UK lagging behind – these developments, through their impact on monetary policy, will lead to a strengthening of the USD
In Q1:2018, US GDP growth was 2.3% qoq (annualized rate), following an outcome of 2.9% in Q4:2017, slightly above consensus expectations. We expect stronger growth in the 2nd half of the year, following the acceleration of the fiscal expansion.
The Fed is expected to maintain its policy stance unchanged at its May 2 meeting (rate at 1.5-1.75%). However, it is expected to resume rate increases in June, and possibly deliver a hike every quarter until end-2018 (2.50%) as GDP growth remains buoyant, the Employment Cost Index (ECI) increased by 2.7% yoy in Q1 (the fastest pace since end-2008) and inflation dynamics are on the rise.
On the other hand, UK GDP growth disappointed (see graph), decelerating to 0.4% qoq saar in Q1:2018, following an outcome of 1.6% in Q4:2017, below consensus estimates. The composition of GDP will be available on May 25th. On top of mixed high frequency indicators for March/April (jobs data, CPI, retail sales), the Bank of England is likely to stand pat at its May 10 meeting (policy rate at 0.50%).
As expected, at its April 26th meeting, the ECB maintained its interest rates unchanged (0% and -0.4%), as well as its forward guidance and the pace of QE (€30bn/month). The overall tone was dovish, with announcements centering on the moderation of economic data in Q1 “from very high levels” but still consistent with strong growth (Q1 GDP: +1.6% qoq saar | 2.5% yoy). The reference to near-term upside risks was dropped from the statement. The discussion for the sequencing of monetary policy was deferred to a later meeting (June/July).
Global equities exhibited high volatility during the past week, as the initial spike in US Treasury yields above 3%, was counterbalanced by strong corporate earnings (S&P500 Q1:2018 EPS growth at 23%, so far, with an average EPS surprise of 9%). Developed market equities were broadly flat during the week, with Energy sector valuations continuing to drive upwards, as oil prices hovered at 4-year highs.
Emerging equity markets underperformed their developed peers on a weekly basis in $ terms by -0.9% (-2.7% in April | +0.2% YtD), with outflows from EM equity and bond portfolios reaching their highest level since early February (-$0.8 billion). Higher US Treasury yields and a stronger USD, reduce the appeal for EM assets. Countries with a large portion of their debt held by foreigners and denominated in foreign currency (UKR, ARG -- see graph), as well as high financing needs (TUR), could be more vulnerable.
The US Dollar appears to have re-established its link to interest rate differentials (see page 3), appreciating by 1.7% in April (DXY Index – at its highest level since January). As higher UST yields and/or a cheaper USD are required to finance the widening US fiscal and current account deficits (-5.9% and -3.4%, respectively, in 2019 – IMF estimates), the sharp increase of 10-year yields (by 22 bps to circa 3%) during the past month pulled up the USD.
Equally importantly, the ECB, Bank of England and the Bank of Japan turned more dovish during the past month (see Economics). As a result, the USD appreciated (see page 11) by 2.0% during April against the EUR to $1.21, by 1.8% against the GBP to $1.376 and by 2.9% against the JPY to ¥109.03.