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Forget Trumpflation
It was all about oil prices this week as the OPEC and non-OPEC producers agreed to extend the production cut deal by nine months into 2018. Even though this was the widely expected scenario, the disappointment reflected in the price reaction appeared to be twofold with cuts not being deepened and no new producers joining the agreement. Nonetheless, it kept some optionality open for cuts being extended beyond the additional nine months should prices decline. Long story short; as oil held its biggest loss in three weeks following the meeting, Saudi Arabia's Energy Minister said the cuts are working and stockpile reductions will accelerate in the third quarter, with inventories falling to the five-year average early next year.
Moreover, according to Russia's Energy Minister Alexander Novak, producers have more tools to further support prices if needed. Back in the US, the2018 initial budget plan indicated cuts of approximately USD 3.6trn over the next ten years by shrinking benefits provided to poorer segments of the US population. Given the linkage of this budget to expected tax reforms, the possibility of lengthy debates in Congress and likelihood of the final numbers looking very different remains very high for now.
On the monetary policy front, the FOMC meeting minutes were released last Wednesday disappointing dollar bulls. The minutes reflected a Fed that sees the first quarter softness as transitory and is prepared to hike in June depending on the data. Moreover, the balance sheet reduction was confirmed as the FOMC intends to gradually reduce the balance sheet assets size. On this matter, Philadelphia Fed President Harker expects the Fed's unwinding of its balance sheet will be "predictable, slow, and as boring as possible...according to his statement, "it will be the policy equivalent of watching paint dry."
Fed's Bullard was slightly on the dovish side saying that US prices are noticeably lower than what they would be if the Fed had reached its 2% inflation target, a trend he considers "worrisome". Bullard also said the Fed's expected rate hike path is "overly aggressive". Dallas Fed President Kaplan was slightly more hawkish saying that he sees two more Fed hikes this year as a base case and that he will advocate raising rates when he sees an opportunity to do so. He also indicated that his economic growth forecast was lower than the 3% figure assumed in the Trump administration's budget proposal.
In Europe, investors' Sentiments remain strong. The manufacturing PMI for the whole Euro area rose to a multi-year high in May, and German business sentiment stands at its highest level in decades. Taken at face value, the strength of the PMIs suggests that the Eurozone economy is booming. Even ECB members seemed less pessimistic over the potential negative effect from the Brexit negotiations on Europe state of affairs. One member stated that "Brexit" will not derail the Eurozone's economic revival as he believes the UK has more to lose than the EU by leaving the bloc: "Brexit is very significant for the UK, but in view of the relative size, it's much less meaningful for the rest of the EU."
On the foreign exchange side, the dollar index opened the week at 97.215 and lost ground to most of its rivals reaching a 6 months low of 96.802 as investors worried about the political uncertainty of the US and the dovish Fed meeting minutes. The index closed the week at 98.00 Higher by over five percent year to date, the Euro traded in a narrow range the entire week as it opened on 1.1200 and reached a high of 1.1267 on the back of Chancellor Angela Merkel mentioning that the "Euro is too weak". The currency closed the week at 1.1178.
The Sterling Pound was weaker as the Conservative Party's lead in opinion polls continues to narrow. The latest polls showed the Conservatives with 43% of the vote against 38% for the current opposition Labor Party. This is the smallest gap since April 2016 and equates to a mere 2 seat majority if this level of support was reflected evenly across the country. This compares to the 17 seat majority the Conservatives currently hold. The currency reached a low of 1.2858 amid the political mess,yet held firm of the 1.2815 support levels. The pair ended the week at 1.2900. In the commodities complex, oil held its biggest loss in three weeks after OPEC's move to prolong supply cuts for nine months disappointed investors hoping for more than the plan that had been flagged days before the group's meeting. Brent and West Texas closed at 52.15 and 49.80 respectively.
Mixed housing due to the lack of new supply
New and existing home sales in April were released this week, and both slipped further than expected. New homes sales were down 11.4% on the month and existing sales were down by 2.3%. April's 569,000new home sales follows an upwardly revised 642,000-unit pace in March which marks the cycle-high, the highest since October 2007.
Sales of existing homes on the other hand were also coming down from hitting a cycle high of 5.7 million-units in March. April re-sales were running at a 5.57 million unit pace. The mild winter weather in the Midwest and Northeast allowed an earlier start for the spring selling season, pulling transactions that usually take place in April into earlier months. During the first four months of the year, new home sales were up 11.3% compared to the same period last year. Existing home sales were up 4.1% compared to the first four months of last year.
It seems that low supply levels held down existing-home sales in April and also pushed the median number of days a home was on the market to a new low of 29 days according to the same report.
In other data, the recent statistics from the manufacturing sector have been mixed. Headline durable goods orders slipped 0.7% in April, which was a smaller drop than expected, and March orders were revised much higher. The second estimates of the first quarter US GDP saw an improvement with the economy expanding 1.2% as personal consumption expenditures was revised from just 0.3% to 0.6%, adding 0.2% to the headline number. Fixed investment and net exports also added more to Q1 growth than first reported, while government spending was less of a drag.
EUROPE & UK
Battle at the Heart of the ECB
The ECB said in its financial stability report that "risks to financial stability from financial markets remain significant, mainly owing to the possibility of a further rapid repricing in global fixed income markets. Such an abrupt repricing could materialize via higher yields in advanced economies, in particular, the United States."
In the minutes of the ECB's April meeting, Peter Praet called on ECB members to be "particularly cautious" on what the central bank's next steps, as any clues could shock financial markets that have become accustomed to mass bond-buying. Benoit Coeure, meanwhile, said in an interview published this week that the ECB needed to change its communication on the recovery soon, or risk losing its credibility.
ECB President Mario Draghi stuck to his view in a speech on Wednesday that tapering comes before raising interest rates. He says negative side effects from QE are larger than from negative rates as the latter are more contained: "Our current assessment of the side effects suggest therefore that there is no reason to deviate from the indications we have been consistently providing in the introductory statement to our press conferences."
Europe's data remain solid
In Europe, data released this week was more upbeat, with Germany's IFO Business Climate Indicator rising to 114.6 in May, the highest level since April 2011, and the manufacturing PMI rising to 59.4 as exporters continued to benefit from EUR weakness. Q1 GDP for Germany was confirmed at 0.6% q/q as expected, with investment and net exports being the key drivers of growth. France's services PMI ready also beat expectations in May, rising to 58.0, while the manufacturing PMI was only a touch softer than April at 54.0.
UK: Revised GDP Growth
News out of the UK continue to depict a negative first quarter for the country. Whether new opinion poll showing Prime Minister May's lead over the opposition had narrowed by five points, the election race could continue to tighten and put pressure on the economy. This week's British Second Estimate GDP was revised to 0.2%, down from 0.3% back in April.
The soft reading comes at a time when other key indicators are missing their estimates, raising concerns that Brexit is finally taking a toll on the British economy. Consumer spending had its worst quarter since 2014, as nervous consumers are holding back.With the gap between nominal wage gains and inflation set to widen in the coming quarters, GDP growth is likely to remain subdued for the rest of the year. In response to the weaker data, investors have started pricing a more dovish Bank of England as the slowdown in UK activity becomes more visible, and see room for further sterling weakness.
ASIA
China Downgraded
Moody's investors Service downgraded China's credit ratings today. The rating agency elaborated by saying it expects the financial strength of the world's second-largest economy to wear away in the coming years as growth slows and debt continues to increase. The one-notch downgrade in long-term local and foreign currency issuer ratings, to A1 from Aa3, comes as the Chinese government grapples with the challenges of rising financial risks stemming from years of credit-fuelled stimulus.
Japan CPI higher than expected
The headline CPI rose 0.4% y/y in April in line with a consensus estimate of +0.4% and up from 0.2% previously. The headline CPI ex-fresh food rose 0.3%, up from 0.2% and below the consensus estimate for 0.4%. The headline CPI ex fresh food & energy was unchanged, up from -0.1% and in line with the consensus estimate. The timelier Tokyo CPI was up 0.2% in May versus 0% consensus and up from -0.1% previously. The Tokyo CPI ex-fresh food increased 0.1%, up from -0.1% and above the consensus of unchanged. The Tokyo CPI ex-fresh food & energy was unchanged, up from -0.1% and in line with the consensus estimate. The services PPI rose 0.7% y/y in April, down from 0.8%.
