08 March 2019

Week ahead: Kick thecan down the road

Andreas Steno Larsen | Martin Enlund

Trade deadlines, Brexit deadlines and Chinese deleverage plans are all kickeddown the road, but there is light at the end of the tunnel in Asia, even thoughhard data are decelerating. A big test is still coming up for the equity rally,though.

Read the report as pdf here.

Read our financial forecast here.

Kick the can down the road, please ...

The can is kicked down the road again, both in the Brexit soap opera and in the trade war. The Britishparliament has asked May to travel to Brussels to ask for a postponement of the exit date, while the Trump-Xisummit is allegedly postponed until April.

The no-deal Brexit risk is now almost completely priced out of markets, after the British parliamentvoted to declare that the UK will take the no deal o the table permanently (even though a senior EUnegotiator described it as “the Titanic voting for the iceberg to get out of its way”). After all, it is hard to seehow May can surprise positively compared to the market pricing by now. A delay of Brexit is on the cards,potentially even a long delay. Theresa May would probably have to serve her own head on a platter to get thewithdrawal deal through the House of Commons in the third meaningful vote next week.

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Chart 1: No deal risks almost priced out of markets with very limited downside potential inEUR/GBP left

China: Hard data struggles, but there is light at the end of the tunnel

The other can-kicker is China, both in terms of trade negotiations and deleveraging of the economy. It nowappears as if Xi Jinping has postponed the prospects of meeting Trump at Mar-o-Lago until April, probablyas too many loose ends of the trade deal are still not agreed upon – including the important FX policyquestion. It is a distinct possibility that China will have to accept bringing back USD/CNY to levelsaround 6.25 (levels at the start of the trade war) if they want the US to accept rolling back the 10% tarisimplemented in 2018. More can-kicking in the negotiations will hence also mean a strong USD for longer.

In the meanwhile, hard data from China continue to decelerate. Industrial production slowed to a yearlygrowth figure of 5.3%. Foreign-funded production declined outright on a yearly basis in February. Thisis a sign that foreign companies move production away from China (or at least refrain from adding newproduction) due to the risks of taris. The deceleration of hard data in China is also the main reason whythe deleveraging process is more or less ocially postponed by now. The NPC only worked to confirm aperception that the PBoC and the fiscal authorities will use whatever tools to reignite the momentum. Couldmore reserve requirement cuts be on the cards in China?

We also find tentative signs of renewed credit growth acceleration in China, and we expect more to come.

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Chart 2: Credit growth could re-accelerate in China as a delayed eect of large liquidityinjections

And while hard data still disappoint in Asia, there may be light at the end of the tunnel, as financial conditionsin Asia have eased since the start of the year. This could indicate an upcoming trough in data such asJapanese machine orders within the next three to four months, but we could still go lower next monthbefore the rebound.

The slowdown in Asian hard data will likely also show up in various US hard data, even though durable goodsheld up relatively well this week. The big risk is still whether the Xi/Trump meeting in April will result in acomplete meltdown of trade negotiations.

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Chart 3: Asian financial conditions suggest decent rebound probability in 3-4 months

Equities versus bonds: A big test is coming up for S&P 500

S&P 500 remains ripe for another test of the 2800-2850 resistance range on the topside. So far this year theequity outlook has received some welcome tailwind from falling real rates, and judging from the relationshipbetween real rates (30 days prior) and S&P 500 over the past year, it seems like the 2019 rebound is moreor less running on fumes by now. Another leg lower in real rates is probably needed to further fuel the risksentiment and the big if is whether the Fed will willingly continue to play along by allowing inflation toovershoot, for instance.

We published our latest asset allocation piece this week, and we advocate underweighting equities, as themacro backdrop, profit expectations, and equity market valuations are all too challenging to us (Nordea View:That came easy, now bet hard)

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Chart 4: Real rates hint at another small leg higher in S&P500, but momentum seems to runon fumes

USD 5y5y inflation has been on the rise lately on the heels of Jerome Powell’s balance sheet U-turn inearly January and also after the Fed has continued to signal a tolerance of slightly overshooting inflation.If you combine a more defensive Fed allowing inflation overshooting, an end to balance sheet contractions(QT) later this year and the momentum for MMT (read: excessive spending) amongst Democrat presidentialcandidates, then the way is potentially paved for even higher 5y5y inflation in USD.

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Chart 5: End to QT might bring about higher 5y5y inflation expectations

In EUR fixed income …

Since EUR core inflation has moved nowhere for several quarters, we judge that the potential rebound inEUR core rates will be driven by a trough in so-called leading indicators for growth. It still seems prematureto expect a rebound in the Euro-area manufacturing sector (more in the section on the week ahead) and thisstill leaves very limited upside risk for EUR core rates the next one to two months. In other words, thereceiver-palooza is likely to continue for another while.

The game changer could be a signed trade document between the US and China (and a weaker USD/CNY),as both could work to re-ignite the global reflation story. If Chinese/Asian data rebound, as indicated by ourmodels on Asian financial conditions, this could lead EUR core rates slightly higher into the early summer.

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Chart 6: Without inflation pressures, PMIs are showing the way for EUR core rates

Scandinavia: Even with a confettied krona, Swedish inflation failedto pick up

The weak SEK is not feeding through while domestic inflation (service inflation) remains modest in Sweden.This week’s CPIF print at 1.9% was another blow for the Riksbank. Inflation simply remains low despite theweak SEK, which means trouble for the Riksbank. A downwards revision of the rate path is now on thecards in April, unless the inflation print in mid-April delivers a massive comeback. However, it wouldbe odd not to see some pass-through from the weak SEK to imported goods over the next one to two months(see model below).

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Chart 7: Weak SEK, no imported inflation. What’s going on?

The case is quite dierent in Norway, as CPI-ATE jumped to 2.6% in February. If it was not a complete donedeal already that Norge’s Bank would hike next week, it is now (more later).

What is most important in the week ahead?

Most focus next week will be given to the FOMC meeting on Wednesday, as the market will be lookingfor signs on how, when and if the quantitative tightening will end. We judge that the current consensusexpects the Fed to end QT by Q4-2019. Any hints on an earlier exit from the QT programme will give ourslightly positive EUR/USD view a boost.

We have the following thoughts on the three major issues ahead of the FOMC meeting:

Patience: The Fed is unlikely to change its stance from “patience” at the March FOMC meeting, with patiencemeaning that rates will remain on hold until it becomes clear whether the economic outlook has worsenedas much as the markets seem to believe or whether it will remain relatively bright when the fog clears as themajority of FOMC members still seem to believe.

Dot migration: Based on recent speeches, we believe that at least half the dots will have migrated lower,reflecting FOMC members’ reduced inclination to hike rates, with the median down to one hike this year(from two in December) and another hike in 2020 (unchanged from December).

QT details: Market sentiment has brightened and the FOMC may decide to keep the announcement of QTdetails for a rainy day, but details could also be announced as early as next week. Our baseline remains QT

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tapering starting in Q3 and ending in Q4 with excess reserves around 1.000bn. It will be negative if the Fedannounces that excess reserves will continue to fall after the end of QT.

Chart 8: Earlier than anticipated end to QT could lead EUR/USD higher (and vice versa)

In the Euro area Draghi and co will be crossing their fingers for a rebound in PMIs next week (Friday), but ifSweden is as good a guide as in 2018, then the Euro-area slowdown is not over yet. We expect anotherweak reading with risks on the downside of consensus. However, at the same time we would like to highlightthat some of our models actually hint of an upcoming trough in Euro-area PMIs three to four monthsfrom now (no models showed that just a few months back).

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Chart 9: If Sweden is as good a guide as in 2018, the Euro-area manufacturing slowdownain’t over yet

In Scandinavia Norges Bank will meet on Thursday. A March hike from Norges Bank is a done deal (alsofor markets), but markets clearly expect a dovish ECB to spill over to fewer Norwegian rate hikesgoing forward. The big question is the extent to which Norges Bank will accept letting international factorsoverweigh domestic factors in the new rate path.

We think they will i) hike by 25 bp, ii) keep a December 2019 hike fairly alive in the rate path, iii) take downthe long end of the rate path. Roughly such a cocktail initially prompted a NOK sello around the time of thehike in September, and to a large extent the situation is comparable to back then. Many, if not all, domesticparameters, argue for a higher rate path. Dovishness abroad argues for a lower rate path.

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Chart 10: Weaker than anticipated NOK could counter eects from lower rates abroad forNorges Bank

In Sweden, we watch out for the monthly HOX/Valueguard house price index on Monday. We stillsee the risk picture mainly tilted to the downside for house prices, as supply remains (very) elevated, whiletransaction data suggest low activity. If the uptrend in prices is reversed again, we may need to call o thelooming stabilisation or rebound in consumption as well.

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Chart 11: Stabilisation in consumption is around the corner if house prices don’t drop again.

Key research pieces over the past week:

Nordea View: That came easy, now bet hard (11 Mar)

Brexit Watch: An extension of the Brexit soap opera (12 Mar)

Swedish inflation February review: More trouble for the Riksbank (12 Mar)

Macro theme: Roadmap to recession (12 Mar)

Fed Watch: March preview - substantial "dot migration" (15 Mar)

Main Releases:

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Monday

The week starts o slowly with a new print of the Swedish HOX/Valueguard home price index and the ECB’sPraet (dove) speaking.

Tuesday

On Tuesday, the focus will be on the UK job report. Additionally, the German ZEW sentiment indicator is likelyto draw attention. Finally, the ECB’s Praet (dove) speaks again.

Wednesday

On Wednesday, markets will likely focus on the US, with the FOMC announcing their latest policy decisions.UK inflation figures are released. In the morning, we get the minutes from the Bank of Japan’s latest MPCmeeting and later that day the Banco Central do Brasil meets.

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Thursday

Thursday is another big central bank day with MPC meetings at the Bank of England and Norges Bank. Fromthe US we get a new print of the Philadelphia Fed manufacturing index. In Brussels a two-day EU summitkicks o.

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Friday

The week rounds o with Euro-area manufacturing and services PMIs. Japanese inflation figures are out inthe morning and the Bank of Russia decides on their policy rate. The EU summit rounds o and the Fed’sBostic (dove, non-voter) as well as the ECB’s Mersch (hawk) speak.

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e-markets.nordea.com/article/47997/week-ahead-kick-the-can-down-the-road

Andreas Steno LarsenGlobal FX/FI Strategistandreas.steno.larsen@nordea.com+45 55 46 72 29

Martin EnlundGlobal Chief FX StrategistMartin.Enlund@nordea.com

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Nordea Bank Abp, Satamaradankatu 5, FI-00020 NORDEA, Finland http://www.nordea.com

 

   

 

 

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