All eyes will be on the Federal Reserve this week, who is widely expected to raise the Fed Funds upper rate from 2.25%-2.50%, and will also be releasing their economic and rate projections. The Fed’s mandate of maximum employment has largely been achieved as the unemployment rate remains steady at 3.7%, a 49-year low. It is the question of the Fed’s perception of the direction of inflation (its second mandate of “stable prices”) that may drive their forecasts.
Inflation has been relatively tamed, given the trend in lower oil prices and a stronger USD, which enables consumers to buy foreign goods at a cheaper level. Factors that could place more upward pressure on inflation could be the higher cost of supplies/goods given the recent tariffs on certain imports to the U.S., rising rents and increased healthcare costs. Further, tight labor conditions have placed higher pressure on wages, ultimately serving as a boon to consumer spending (see more below).
Outside of the domestic economic backdrop, the Fed will consider slower economic growth abroad as data both out of China and Europe continue to disappoint (see below). Geopolitical risks remain, including the Italian budget crisis, a smooth Brexit and the potential of a U.S. government shutdown if Congress and President Trump cannot come to an agreement regarding the spending bill by December 21st.
The FOMC meeting aside, both the Bank of Japan and the Bank of England are scheduled to meet this week, with both expected to keep their key rate levels unchanged at -0.1% and 0.5% respectively. Further, a slew of data both domestically and abroad is scheduled. The Fed’s favored measure of inflation, U.S. durable goods data and third quarter GDP to be released towards the end of the week. Key inflation and GDP data are scheduled for major markets outside of the U.S. as well (see below).
Last week, concerns regarding slowing global growth drove equity markets lower with all three major U.S. stock indices ending the week in the red. The Dow Jones fell 2% on Friday, given the weaker data out of China and Europe. Separately, news that U.S. corporate Johnson & Johnson knew its baby powder product had asbestos, but kept the information private, placed downward pressure on equity indices.
Positive trade rhetoric from both China and the U.S. spurred Treasury rates to edge higher earlier in the week, although yields dropped on Friday on the back of the aforementioned weaker economic data. Nevertheless, ten-year Treasuries closed the week higher at 2.891%.
I. U.S. Economic Data/Markets
- November U.S. Core Retail Sales increased by 0.9%, beating expectations of 0.4%.
- The data reaffirmed the economic momentum in the U.S., reaffirming the likelihood of a Fed rate hike this week.
- October data was revised from 0.3% to 0.7%.
- Tight labor conditions, increased confidence, higher wages likely contributed to the data.
- Consumer spending reflects about two-thirds of U.S. GDP.
- The U.S. Dollar index, which measures the dollar against a basket of six currencies increased by 0.43% on the back of the data.
- U.S. inflation (as measured by the consumer price index) rose 2.2% in November, down from the rise of 2.5% in October.
- Core CPI (excluding food and energy increased 2.2% y-o-y.
- Higher healthcare costs, rising rents primarily drove the data.
- Industrial Production rose 0.6% in November, driven by utility output which was largely induced by the colder weather.
- Factory production was unchanged and revised data for October reflected a 0.1% decline in manufacturing – a higher USD, tariff uncertainty and a general slowdown in global demand could partly be attributed to the data.
- China/U.S. trade tensions were somewhat alleviated given the following:
- China’s vice-president announced its willingness to open its markets to foreign companies and “lead economic globalization”.
- Chinese buying a large number of soybeans from U.S. farmers, which appeared as an act of goodwill. It was also reported that Chinese state oil trader, Unipec, will buy U.S. oil.
- China’s Ministry of Finance announced the suspension of tariffs on American-manufactured automobiles and parts for three months effective Jan. 1.
- Brexit: U.K. Prime Minister survived the confidence vote midweek, obtaining 63% of her party’s support. After hitting a 20-month low against the USD before the vote, the GBP rallied about 1.14% after the voting results were announced, trading around $1.2635. Sterling has dropped about 13% since Brexit was announced in June 2016.
- May offered to not seek re-election in 2022 in part for supporting votes.
- Post the confidence vote, May said she would work with the EU to improve the Brexit deal. The U.K. parliament has until January 21st to vote on any proposal.
- Chinese economic data reach multi-year lows.
- Growth in retail sales dropped to its lowest level in 15 years rising 8.1% in November y-o-y versus 8.6% in October.
- Industrial production grew 5.4% y-o-y (the slowest pace in almost three years) versus expectations of 5.9%.
- The offshore yuan weakened nearly 0.4% versus the USD on the back of the data.
- Eurozone business growth falls to a four-year low as measured by the Flash Eurozone PMI Composite Output Index, coming in at 51.3, a 49-month low.
- Job creation fell to a two-year low, business optimism also fell sharply.
- Weak demand, in particular for autos and recent protests in France partly drove the data.
- Activity with the French private sector fell to 49.3, the first time the level has fallen below 50 since 2016, indicating a drop in output.
- Similarly German saw its PMI drop to 52.2, its lowest level in four years.
- European Central Bank confirmed that it will end its quantitative easing program by the end of the month, where bond purchases will fall to zero from EUR 15 billion a month.
- ECB noted it will reinvest cash from maturing bonds for an extended period of time.
- Keep in line with its previous statement, the ECB left its unchanged at 0%.
- Geopolitical risks linger across the EU and will likely weigh on the ECB going forward, including Italy’s budget crisis, French budget concerns, and the recent protests, uncertainty surrounding a smooth Brexit.
Key data/events this week:
- EUR CPI (Monday)
- AUD New Home Sales (Tuesday)
- AUD mid-year economic and fiscal outlook
- AUD RBA meeting minutes
- German IFO data
- U.S. Housing Starts
- U.S. Building Permits
- JPY trade data
- German PPI (Wednesday)
- GBP retail price index
- GBP/CAD CPI
- U.S. Existing Home Sales
- FOMC rate decision/projections/statement/press conference
- NZD trade data
- NZD GDP
- JPY foreign bond and stock holdings
- AUD employment data (Thursday)
- Bank of Japan rate decision/press conference/statement
- GBP retail sales
- Bank of England rate decision/minutes/assets purchase facility
- U.S. Philadelphia Fed Manufacturing survey
- JPY CPI
- German/GBP confidence surveys (Friday)
- GBP/U.S. GDP
- U.S. Durable Goods
- U.S. Personal Consumption Expenditures