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Stock markets open higher. Key data this week is UK CPI on Tuesday and US CPI on Wednesday as investors seek clues on inflation outlook.

By Nick Parsons

So far, we’ve only had one of the fifteen trading sessions that we get each week across the three major time-zones, so it’s unwise to draw any firm conclusions from the price action. That said, there is at least a consistent theme which is for a modest rebound in global equities and a somewhat lower US Dollar. Putting any numbers in a commentary risks instantly dating it, but as we go to print this Monday morning, futures markets are signally around a 200 point gain for the DJIA with the USD index a couple of tenths lower. GBP/USD on Friday clawed its way back on to a 1.38 ‘big figure’ after a low in the 1.3770’s and during the Asia session has added around a quarter of a cent.

In economic news, The Times newspaper splashes with the headline, “consumer spending falls to its lowest in five years”. The paper reports household spending fell by 1.2% in January compared with 12 months ago, according to research by Visa, the payments business. It is the first time that there has been a decline at this time of year since 2013. Individuals’ spending has now fallen in eight of the past nine months, with clothing, furniture and household goods bearing the brunt of consumers’ caution, according to figures on spending on Visa cards, which account for more than £1 in every £3 spent in the UK. According to Markit, ““Subdued spending trends coincide with a slowing of the overall UK economy during 2017. Lingering uncertainties around the outcome of the Brexit negotiations are also weighing on consumer confidence, which has stayed well below the levels seen prior to the 2016 Brexit vote.”

The weekend Press in the UK seems to have taken a break from bashing the government, though this is more likely to be a tactical retreat rather than any great change of strategy. Having said nothing of any substance on Brexit since a speech in Florence back in September last year, UK PM Theresa May is set to give her next major set-piece in Berlin in three weeks’ time. Before then, senior ministers are due to set out this week Britain’s “road to Brexit”, with Foreign Secretary Boris Johnson said to be making the case for a “liberal Brexit” designed to reassure Remain voters. In economic news, the big event will be Tuesday’s CPI figures. Inflation last month slowed from 3.1% to 3.0% and consensus looks for another drop to 2.9% in January. With BoE interest rate policy now aligned very closely with current and expected inflation, it should be a straight read-across for the GBP.

After the previous Friday’s spooky 666-point sign of things to come for the Dow Jones Industrial Average, there were two daily 1,000-point declines last week. Friday looked set for another huge drop before the index then bounced sharply off its 200-day moving average to end the day almost 900 points off its midday low. The US Dollar generally does well in times of equity market turmoil and last week was no exception. From its opening level of 88.90 last Monday morning in Sydney, the USD index against a basket of major currencies rose steadily to a high on Thursday of 90.25; its best level since before Treasury Secretary Mnuchin’s comments in Davos two weeks’ earlier. Overnight in Asia as the equity market has edged cautiously higher, so the USD has given back around two-tenths of a point to 89.80.

None of the scheduled Fed speakers last week seemed at all concerned by the stock market. Federal Reserve Bank of New York President William Dudley said recent declines weren’t that big and don’t yet change his outlook for the U.S. economy. “This wasn’t that big a bump in the equity market… The stock market had a remarkable rise over a very long time with extremely low volatility…. My outlook hasn’t changed just because the stock market’s a little bit lower than it was a few days ago. It’s still up sharply from where it was a year ago. Having a bump up like this has virtually no consequence on my view of the economic outlook”. This view was largely echoed by Kaplan, Harker, Evans and others. Indeed, there are few signs from the front end of the US money market curve that a 25bp rate hike at the March FOMC meeting is in any more doubt. Two weeks ago, with the stock market at a record high, the market-derived probability of a hike was 76%. Today, it has edged down only very marginally to 72%.

To the extent that the 2.9% increase in average hourly earnings was the ‘trigger’ for the stock market sell-off, investors will now be acutely sensitive to any inflation data. On Tuesday we have the NFIB small business survey which contains a question on earnings. Last month’s Press Release breathlessly enthused that, “2017 was the most remarkable year in the 45-year history of the NFIB Optimism Index… With a massive tax cut this year, accompanied by significant regulatory relief, we expect very strong growth, millions more jobs, and higher pay for Americans.” NFIB Chief Economist Bill Dunkelberg said, “There’s a critical shortage of qualified workers and it’s becoming a real cost driver for small businesses… They are raising compensation for workers in order to attract and keep good employees, but that’s a positive indicator for the overall economy.” It may not be so good for the stock market which will be on edge, also, ahead of Wednesday’s CPI numbers.

The euro had a remarkably calm week stuck between the opposing forces of stock market turmoil which was good for the USD and further strong economic data in the Eurozone. Indeed, since Wednesday lunchtime, EUR/USD has remained on a 1.22 ‘big figure’ with the volatility elsewhere in global asset markets completely passing it by. Overnight in Asia the pair has edged modestly higher in line with a recovery in stock index futures but with no economic data scheduled for release today, the focus away from equities might still be on political developments in Germany.

Whilst there is relief that Germany has avoided a fresh, destabilizing Federal Election, there is concern amongst analysts and investors that Ms Merkel might have conceded too much to the left-wing SPD. Reports suggest that the SPD will be handed the Finance, Labour and Foreign Ministries - a major victory for the Social Democrats - while CSU leader Horst Seehofer, one of the most conservative figures on Merkel's side, would become Interior Minister. Over the weekend, a cartoon in Der Spiegel magazine shows Angela Merkel naked while SPD politicians run away with her clothes, whilst Die Zeit has a cartoon of German eagle crash landing on its head…

There are plenty of ECB speakers again this coming week, chief amongst them Bundesbank President Jens Weidmann who last Thursday said, “The favourable economic outlook lends credence to the expectation that wage growth and therefore domestic price pressures will gradually increase in keeping with a path towards the Governing Council’s definition of price stability… If the expansion progresses as currently expected, substantial net asset purchases beyond the announced amount do not seem to be required”. As for the currency, ““The recent appreciation of the euro seems unlikely to jeopardise the expansion… Research suggests that the exchange rate pass-through, which is to say the impact of exchange rate movements on inflation, has declined.” The EUR opens in Europe today on ‘big figures’ of USD1.22 and GBP/EUR1.12.

The three main drivers of most of the valuation models of the Australian currency are commodities, interest rate differentials and volatility. When asset markets are quiet, the incremental returns from higher interest rates look quite attractive. As we’ve said before though, when markets are very volatile, this strategy can be likened to picking up pennies in front of a train. Many investors unfortunately got run over last week as volatility surged and all three of the valuation metrics for the AUD turned negative. Gold is more than $40 off its recent high of $1264 per ounce whilst the RBA has signaled it is in no rush whatsoever to be raising interest rates. All this together pushed AUD/USD last week back on a 77 cents ‘big figure’ for the first time since late December. On Friday, the pair rallied very slightly into the NY close at 0.7810 and the rally in equity markets overnight has seen it extend another quarter of a cent higher.

On Friday, the RBA released its latest Quarterly Statement of Monetary Policy; a 68-page document summarizing the current state and future outlook for the Australian economy. The main phrase for interest rate and currency markets was that, “Over the course of 2017, the unemployment rate declined and inflation increased a little. The accommodative setting of monetary policy has played a role here. Further progress on both fronts is expected over the next couple of years. It will be some time, however, before the economy reaches current estimates of full employment and inflation returns to the mid-point of the target”. It is interesting to see the RBA is now stressing the ‘mid-point’ of the inflation target and it is this which has prompted ANZ Bank to change its interest rate forecasts. It was previously looking for 2 hikes this year but now sees the RBA on hold throughout 2018.

Away from the turmoil in global equity markets, the two main domestic highlights in terms of economic data this week are the NAB Survey on Tuesday and the labour market report on Thursday. It seems pretty clear from what the RBA have written and said that wage growth probably holds the key to monetary policy. If employment picks up without any upward pressure on pay, then there’ll be no rush to raise interest rates. RBA Assistant Governor Luci Ellis is scheduled to speak this evening though this is at an ABE forecasting conference and might well focus on technical aspects of the data rather than offering any macro policy clues.

The Canadian Dollar began last Monday around USD/CAD1.2430 but as the week progressed and the USD was persistently well-bid, so USD/CAD moved sequentially higher. On both Thursday and Friday, it briefly broke through the upper end of its 2018 trading range from the mid 1.22’s to the high 1.25’s but settled back by the New York close despite a near-10% weekly drop in crude oil prices which has taken WTI down from a recent high of $66.50 per barrel on January 25th to just under $60 today.

Over the weekend, Canadian Prime Minister Justine Trudeau finished a 3-day trip to Chicago, San Francisco and Los Angeles as he attempts to win support from US lawmakers and businesses to keep Trump from pulling out of the North American Free Trade Agreement. As reported by Bloomberg, Trudeau spoke on Friday night at the Ronald Reagan Presidential Foundation & Institute, where he hailed Canada-US ties. He recalled meeting Reagan when Trudeau’s own father, Pierre, was Canada’s prime minister. “I’d just received a master’s class in political charisma, and one I like to think kind of stuck,” he said. In Los Angeles he said he didn’t “think anyone can now entirely predict or understand” the impacts on the three countries if NAFTA were to end. “This accord should and can be modernized and updated, with effort, hard work and willingness to compromise on all sides, this is eminently achievable. If trade between Canada and the US is a bad idea, then there are no good ideas.”

Last week’s major economic news in Canada was Friday’s employment report where consensus looked for a 10k rise after a 78k gain in December. Instead, Stats Canada reported employment fell by 88,000 in January. Part-time employment declined (-137,000), while full-time employment was up (+49,000). At the same time, the unemployment rate increased by 0.1 percentage points to 5.9%. On a year-over-year basis, employment grew by 289,000 or 1.6%. Gains were driven by increases in full-time work (+414,000 or +2.8%), while there were fewer people working part time (-125,000 or -3.5%). USD/CAD surged to the mid 1.26’s when the numbers were announced as computer-driven algorithms responded to the headlines but within a few minutes, nearly all the gains had evaporated when it was realized that all the job losses were in part-time and seasonal employment. The 1.25 area now seems a comfortable place for USD/CAD, with one Canadian Dollar worth 80 US cents.

After the first 1,000-point drop of the week for the DJIA last Monday, the NZD was boosted by some technically driven selling of the key AUD/NZD pair which fell through a big support level of 1.0850 and tumbled all the way to a 6-month low in the mid-1.07’s. Indeed, on Tuesday the NZD was the best performer of all the major currencies we follow closely here. Against the USD, however, the Kiwi Dollar fell on Thursday to a 71 cents big figure; the weakest in 4-weeks before a recovery on Friday took the pair back up to the mid-0.72’s.

Statistics New Zealand reported this morning that consumers spent more on eating out and on hardware, furniture, and appliances in January 2018. This contributed to a 1.4% rise in total retail card spending in the month, when adjusted for seasonal effects. Spending rose across four of the six retail industries last month. The largest movements were: hospitality, up $15 million (1.5%) durables, including hardware, furniture, and appliances, up $14 million (1.2%) and fuel, up $9.0 million (1.5%). Core retail spending (which excludes the vehicle-related industries) rose 1.0% in January, after a 0.2% fall in December 2017. Cardholders made 141 million transactions across all industries in January with an average value of NZ$50 per transaction. The total amount spent across all transactions was NZ$7.0 billion.

The RBNZ claims to be living in “central bank nirvana” and for all the volatility in global asset markets, it does seem there’s nothing much to trouble policymakers locally this week. On Wednesday we have data on food price inflation and then it’s the manufacturing PMI survey on Friday. None of these are likely to trouble those in charge of setting interest rates though there’ll be some interest (no pun intended!) in its own quarterly survey of inflation expectations which is released midweek.