Trade optimism remains the key driver of risk appetite
Markets continued to recover in the past week, as optimism regarding trade negotiations between the US and China supported risk appetite. Furthermore, US Congress approved a spending bill, thus avoiding another federal government shutdown. Global equity markets rebounded strongly by 2% on a weekly basis (+9% ytd), led by developed markets (+2.3% wow), while bond yields rose slightly (10Yr UST: +3 bps to 2.66%).
Progress continues on US-China trade negotiations, according to officials, but several issues remain, including technology regulation and industrial standards. President Trump stated that “there is a possibility” of extending the deadline beyond March 1-2, suggesting increased chances of reaching an accord. Discussions are expected to continue this week in Washington. With investors monitoring closely trade developments, tariff-sensitive sectors outperformed in the past week (US industrials: +3.5%, Euro Area autos: +5%).
As expectations have increased, a comprehensive trade deal is necessary for the risk asset rally to continue. Moreover, trade-related risks remain, especially for the auto industry. The US Commerce Department submitted to the White House its “Section 232” auto imports investigation findings (which started in May 2018). The report, whose content has not been disclosed, may recommend tariffs (of up to 20%-25%) on imported autos and/or auto components, with the White House having a 90-day period to decide on the recommendations.
Incoming data confirm the view that global growth slowed significantly in Q4:18 (MSCI ACWI: -13%), albeit the major issue for policymakers and investors is whether the deceleration will continue in 2019.
Estimates for Q4:18 US growth (due on February 28) were revised down to c. 1.5% - 2.2% qoq annualized compared with c. 2.4% a week ago (Atlanta Fed and New York Fed nowcast) and 3.4% in Q3:18, following disappointing retail sales data for December (January data due on February 25-28). Nevertheless, the robust labor market (wages, jobs growth) and still healthy consumer and manufacturing sentiment leave room for optimism. Moreover, the Chinese authorities’ policy easing may have started to bear fruit as credit data recovered strongly in January.
In the euro area, the release of business surveys will be announced on 21 February. Consensus expects a broadly stable February composite PMI (51.1). Thus, underlying growth will likely be around 0.6-0.8% qoq annualized in Q1:19, largely matching the average pace of growth in H2:18 (0.7% qoq). Officials have suggested that the ECB could provide support (e.g. alter its interest rate guidance) if soft economic activity persists.
Following the granting of a further two weeks for further negotiations by the UK Parliament, PM May is expected to hold talks with EC President Juncker, in an effort to seek legally binding changes to the Irish backstop and convince UK MPs to support the Withdrawal Agreement. However, no significant progress is expected. Parliament will vote again on February 27th regarding extending the date in Article 50 (March 29).