Next week’s market movers
- In the UK, all eyes will be on the General Election. A strong showing by the Conservatives is likely to raise speculation that PM May could negotiate a better Brexit deal with the increased domestic support she will gain.
- In Eurozone, the ECB policy gathering will be closely watched, considering the heightened speculation that policymakers could shift to a more optimistic bias.
- We expect the RBA to maintain a balanced tone. Even though domestic data are improving, signs that economic activity may be cooling in China could raise concerns for policymakers.
- In the US, former FBI Director Comey will testify before the Senate. Focus will be on the whether President Trump attempted to influence an FBI investigation. Any confirmation of that could unleash a political maelstrom.
- We also get key economic data from Australia, China, the UK, the US, and Canada.
On Monday, the UK services PMI for May is due out and the forecast is for a decline. Even though the manufacturing index for the month fell as well, the construction index rose notably, which does not paint a clear picture. As such, we expect investors to focus on the services figure to determine how the economy performed in May, bearing in mind that the service sector accounts for the vast majority of UK GDP. That being said, we think that with the General Election just around the corner, political developments are likely to overshadow economics and thus, incoming opinion polls could remain the main driver of sterling over the next few days.
From the US, we get the ISM non-manufacturing PMI for May and the consensus is for the index to have declined somewhat. However, such a decline would still leave the figure at a very elevated level, consistent with strong growth in the non-manufacturing sector. Therefore, we doubt that such a modest pullback will materially alter investors’ expectations regarding the Fed’s hiking plans from June onwards.
Markets will remain closed in Germany, France, Switzerland, Norway and Sweden in celebration of Whit Monday. New Zealand markets will stay closed as well for the Queen’s Birthday holiday.
On Tuesday, during the Asian morning, the RBA policy decision will be in focus. The forecast is for the Bank to keep its policy unchanged. In the minutes of its latest gathering, the RBA reiterated its concerns about the labor market, indicating that it is "carefully monitoring" developments. Nonetheless, April’s employment data that were released after that meeting were particularly strong, and we think that the Bank is likely to acknowledge this progress. That said, we expect policymakers to refrain from appearing too upbeat. Even though Australian data are improving on the whole, some forward-looking indicators of the Chinese economy suggest that economic activity there is cooling. Specifically, the Caixin manufacturing PMI entered the contractionary territory in May, which is likely to be worrisome news for the RBA, considering Australia’s heavy trade exposure to China. What’s more, the fact that iron ore prices have continued to slide since the latest RBA meeting enhances the argument for a balanced tone by policymakers
On Wednesday, the only event that could attract market attention is Australia’s GDP for Q1. Without a forecast available, we see the case for the nation’s economic growth to have slowed from an astonishing +1.1% qoq in Q4. Even though the labor market continued to tighten and iron ore prices remained elevated, retail sales missed their forecasts and barely rose throughout the quarter, suggesting that the robust +1.1% qoq is unlikely to be sustained, in our view.
On Thursday, we have an extremely busy day, with a UK General Election, an ECB policy meeting, and a testimony by the former Director of the FBI on the schedule.
Kicking off with the UK election, opinion polls suggest that the Conservative Party, led by Prime Minister Theresa May, is poised for a landslide victory. According to a rolling average of recent polls, even though the Conservatives have lost some of their lead recently, they are still expected to secure 44% of the total vote, with Labour tracking behind them at 35%. Considering that a Conservative victory is very widely anticipated, we think that market focus will be primarily on the percentage that the party manages to secure, as opposed to whether it will actually win. A strong showing by the Conservatives that gives them a clear majority in the House of Commons is likely to prove positive for sterling, on the grounds that PM May could manage to negotiate a better Brexit deal with the increased domestic support she will gain. That being said though, given sterling’s sharp rally after Theresa May announced the snap election, most of the good news may already be priced into the currency. As such, even though there could be some further upside in GBP in case of a strong Conservative victory, we believe that any surge is unlikely to be major. This view is enhanced by the fact that the next political risk, the Brexit negotiations, are set to begin a few days later on the 19th of June.
Therefore, we think that the risk here for sterling is a weaker-than-expected showing by the Conservatives, which leaves them with a very small majority in Parliament, or even no majority at all. In the latter outcome, the Conservatives would need to form a coalition with another party, or govern with a minority. Thus, in both of these scenarios Theresa May would likely have less domestic support than previously anticipated and consequently, her hand in the Brexit negotiations may be weaker. Therefore, in case of an underwhelming showing by the Conservatives, we would expect the pound to tumble, perhaps significantly.
In Eurozone, all eyes will be on the highly-anticipated ECB policy gathering. With no expectations for any actual change in policy, market focus will probably be on whether the Bank will shift to a more optimistic bias. Recent media reports have suggested policymakers will likely acknowledge the recent improvement in the outlook for economic growth, by indicating that the risks surrounding that outlook are no longer tilted to the downside but are instead "broadly balanced". These reports also said the Governing Council will discuss whether it should drop its dovish forward guidance regarding a potential expansion of the QE program and the indication that rates could be reduced further if needed.
We share the view for an upgrade in the assessment of risks regarding GDP growth, but we think it is too early for the ECB to alter its dovish forward guidance, for a variety of factors. First and foremost, such a rapid change in language from policymakers could be over-interpreted by markets as a preliminary hint to tapering, which could result in a sharp appreciation of the euro as well as a spike higher in the bond yields of euro area economies. Additionally, it is not clear whether the recent upswing in the core inflation rate is self-sustaining and durable, as Draghi pointed out recently. Finally, the ECB President also noted that an extraordinary amount of monetary policy support is still needed, including through the use of the Bank’s forward guidance. In our view, this implies that the Bank’s language is unlikely to be changed so drastically so quickly.
Last but not least, in the US, former FBI Director James Comey will testify before the Senate Intelligence Committee. The testimony will likely center around whether President Trump attempted to influence an FBI investigation regarding ties between Trump’s prior security advisor Michael Flynn and Russia. Even though financial markets usually do not focus on such events, we think that they will probably pay attention to this one, as it may hold implications for Trump’s tax-reform agenda and his administration’s ability to push it through Congress.
Should Comey confirm that Trump asked him to drop the investigation, as has been suggested by media reports, we could see renewed political turmoil in Washington D.C. Investors could begin to question whether Trump can be impeached over this, and consequently, whether he can manage to implement the reforms he has promised, amid so much political controversy. Something like that could prove negative for the dollar, not only due to the elevated uncertainty, but also due to a potential further unwinding of the "Trump trade". On the other hand, if Comey indicates that nothing like that ever occurred, we could see this cloud of political uncertainty being lifted, which could prove positive for the greenback, in our view.
As for the economic indicators, China’s trade balance for May is due to be released during the Asian day, though no forecast is available for any figure yet. Our own view is that exports likely rose again, possibly at a similar pace as last month. We base that view on the nation’s official and Caixin manufacturing PMIs for the month, both of which showed that new orders from abroad continued to rise, but at a relatively subdued pace. Meanwhile, we see the case for imports to have risen at a somewhat slower pace than the previous month, considering that the Imports sub-index of the official PMI declined to reach the 50 mark, indicating stagnant imports from companies.
On Friday, during the Asian morning, China’s CPI and PPI for May are due to be released. Without any forecast available, we see the case for both the CPI and the PPI rates to have declined from previously. We base our view on the nation’s Caixin manufacturing PMI for the month, which showed that as a result of lower raw material prices, firms reduced their final prices for the first time since February 2016. Even though further decline in the CPI rate could be somewhat worrisome for the PBoC, we doubt that policymakers will ease policy as a response, unless the situation deteriorates notably. In fact, the PBoC has been gradually tightening its policy recently, mainly as a response to financial stability risks, such as the rapidly rising house prices in major Chinese cities. Thus, we believe that for the time being, financial stability concerns are likely to overshadow any modest slowdown in inflationary pressures or economic growth.
In Canada, employment data for May will capture market attention, though no forecast is available yet. Our own view is that the nation’s unemployment rate may have remained unchanged following a notable drop in April, and that the net change in employment may have risen from previously. We base this on the Markit manufacturing PMI for the month, which showed that manufacturers reported one of the strongest rates of job creation in five-and-a-half years. Something like that would likely be another piece of encouraging economic data for the BoC, and it could raise some speculation regarding an increasingly more optimistic tone by the Bank in the future.
