31 August 2018
US: Still feeling it…

Consumer confidence has improved again in August as the strong jobs market, massive tax cuts and buoyant asset prices keep households in the mood to spend

The final reading of August University of Michigan consumer confidence has improved to 96.2 from the preliminary figure of 95.3 and suggests households remain very positive on their own personal situation and that of the US economy. This follows from last week’s Conference Board measure, which rose to an 18 year high. However, the chart below shows there is some divergence between the two series emerging right now, which we should keep an eye on.

With the jobs market going from strength to strength and tax cuts putting more money in peoples’ pockets, there is a strong appetite to spend. Rising home and equity market prices are also boosting household wealth, so it is little surprise to see optimism is at such strong levels. The only thing missing is wage growth, which continues at a subdued 2.7% rate - slower than headline inflation of 2.9%. If we can see the pay story improve (we look for wage growth to pick up to 2.8% next Friday) this could see sentiment hit new record highs.

As such we expect consumer spending to remain a key driver of US economic activity. Consumer spending rose at an annualised rate of 3.8% in 2Q18, and we look for another 3% figure in Q3, helping to fuel full year US GDP growth of around 3%. With annual inflation at or above 2% on the headline and core (ex-food and energy) measures this suggests the Fed will continue hiking rates in a “gradual” fashion. We look for both a September and a December Fed rate hike with two further moves next year.

Eurozone core inflation declines to 1% and becomes a bigger worry for ECB

Headline inflation drops to 2%, but the real story is core inflation falls back to 1%. The ECB will monitor this carefully in the coming months as core inflation needs to pick up for the conditional path of monetary tightening 

Headline inflation remains elevated due to the energy price jump in the first half of the year, causing energy price growth to be 9.2% in August. This effect has started to slowly fade out of the inflation rate, meaning that inflation will slip below target in the months ahead. Core inflation is therefore much more interesting to look at. For a sustained higher inflation rate, it needs to move up, and the much-anticipated acceleration has so far failed to happen.

There is hope for higher core inflation though. Perhaps the most interesting data point to come out this summer was Eurozone negotiated wage growth, which jumped from 1.7% to 2.2% year on year in Q2. This significant acceleration brings wage growth to a pace last seen in 2012 and gives the first indication that the long labour market recovery is starting to lead to increasing wage pressures. Still, while concerns about the ECB being behind the curve have already been voiced, today’s core inflation reading suggests the contrary.

In the coming months, the question remains whether businesses will dare to increase prices on the back of higher wage growth in times of weakening business confidence. Surveys indicate slower expected price growth in the months ahead as global economic uncertainty has impacted the business outlook. 

The European Central Bank needs improved core inflation to stay on track for its conditional path towards the end of quantitative easing in December and a rate hike at the end of summer 2019.

GBP: Barnier’s Brexit Boost

GBP markets were caught off guard as the EU's Brexit negotiator Michel Barnier said they were "ready to propose a partnership the likes of which has not existed before with any third country". This is something that most hadn't thought was possible and may see a partial reassessment of no deal Brexit risks that lends support to a politically-infested pound

Summary: Chasing GBP lower on no deal Brexit risks becoming highly unattractive

While the politically-infested pound has been living on a prayer in recent weeks, we think that a lot of bad news is now priced in – such that risk-reward no longer favours chasing the marginal pricing in of no deal Brexit fears. The pound's sharp 0.7-0.8% rally in response to Barnier's somewhat constructive comments (albeit the rest of the rhetoric towing the usual EU party line) reflects this risk-reward trade-off. Given the extent to which leveraged funds have turned short GBP in recent months (see chart above), we feel that GBP will now be more sensitive to constructive Brexit headlines – versus being vulnerable to negative (or status quo no deal Brexit) noise. More positive Brexit headlines could see leveraged funds further bail on their short GBP positions; a neutralisation of GBP positioning would see GBP/USD moving back to the 1.31-1.32 area (EUR/GBP back to 0.88-0.89).

Indeed, when it comes to Brexit and the currency, talks between the UK and the EU are not necessarily the primary short-term risk. In fact, some investors may have found comfort from the UK-EU talks – especially as it was clear that the EU isn’t actively looking to push the UK off any Brexit cliff edge (which makes sense given that a no deal Brexit would be somewhat damaging to both economies).

The inherent willingness of both sides to find a Withdrawal Deal solution should serve as a bit of a backstop to the degree of no-deal Brexit risks priced into the currency. But when it comes to GBP and political risks, it is far too early to signal the all clear; the biggest test for the pound will be the return of a divided UK parliament from their summer recess and the upcoming Party Conference Season. A murky UK political backdrop may continue to put a dampener on GBP upside in the near-term – but we do think that a good chunk of Brexit negativity is priced in and look for a stable, albeit Brexit-headline-sensitive, GBP.

Below we reiterate some of our short-term and medium-term views – as well as our Brexit scenario analysis matrix.

France: Hard times for Macron

The last consumer spending figures were weak in July, while consumer confidence declined in August. The economic situation is not helping a government weakened by the departure of its most popular minister

Household spending showed signs of weakness in July

Figures published this week by INSEE showed that household spending increased by a limited 0.2% month-on-month in July. Spending growth is still below 1% on the year. Looking at the long term trend, it seems that spending growth has been declining slightly since mid-2015 despite improvements in consumer confidence. Indeed, consumer confidence, which was also published this week, was at 96.6 in August, which is consistent with spending growth of almost 2% a year.

What the survey showed, however, is that the trend in consumer confidence is now down. While 96.6 remains a higher level than in any month between 2015 and 2016, it has been on a downward trend since December 2017 (104.3). Looking at the components, it appears that households are more positive about their savings now than in December, but this further improvement has been counterbalanced by returning pessimism about the economic outlook and, since June, a return of unemployment fears.

The latter comes from the fact that the unemployed population has increased almost every month since March despite an increase in hiring intentions and labour market reform (the effect of ending subsidised contracts has abated since June). In the service sector, the last PMI surveys showed that the improvement in the unemployment rate in recent quarters could pause unless there is an increase in demand.

Sweden: Krona at multi-year low and decline isn’t over yet

SEK continues swimming naked. Despite reaching a new multi-year low vs the EUR, we look for further SEK weakness (to EUR/SEK 11.00) as both domestic and external factors weigh on the currency

A new multi-year low

EUR/SEK broke above the May high of 10.6960 reaching the highest level since 2009. This is in line with our bearish SEK view and our non-consensus target of EUR/SEK 11.00 by the year-end.

When value and price collide

What is and isn't acceptable in pricing can highlight fascinating insights into how consumers and businesses behave

Imagine you've bought tickets for yourself, another adult and two children to see a film at the local cinema of a national chain. You then search online and find you could have paid nearly half if you saw the same film with the same chain but somewhere else. This does not seem fair. This example is taken from a BBC press report noting parents’ objections to paying £34.16 ($40) for tickets to a cinema in Carmarthen in Wales compared with £19.00 in Cardiff, the Welsh capital. That’s 45 percent less.

The accusation of price gouging seems reasonable at first glance

A lack of alternative cinemas and therefore competition in Carmarthen has been blamed by a campaigner for the difference. To rub salt in the wounds, the price for similar tickets at the closer Welsh city of Swansea was £22.96 – still 33% lower. The objection is easy to understand, especially when parents are trying to entertain children during holidays and weekends, and when budgets are stretched. It’s useful to note that incomes around Carmarthen are about 25 per cent lower than in Cardiff. The accusation of price gouging seems reasonable at first glance. After all, the cost of putting on the film is unlikely to be nearly double in one location compared with the other. The price difference and consumer reaction provide some interesting illustrations of how consumers and businesses behave.

Reading time around 8 minutes

In case you missed it: Deal or no deal?

Is a Brexit deal finally within reach? EU Brexit negotiator Michel Barnier said this week that the bloc was willing to offer an unprecedented partnership to the UK. We explain what this means for the pound and why it makes sense for Europe, which is facing its own set of challenges in the form of a 'silver tsunami'  

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