Sun, 05 Aug 2018 02:45 IST
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Deutsche Bank Early Morning Reid – August 1, 2018

August gets off to a busy start today as we have the FOMC’s policy decision and manufacturing PMIs from both sides of the Atlantic. We’ll review July at the end and include all our usual performance review charts and tables in the pdf. First though we’ll preview the Fed. DB’s Peter Hooper thinks that whilst recent US data has been disappointing it is still mixed enough for the Fed to refrain from any major announcement today. Given that this meeting sees no press conference or forecast update, the September meeting would perhaps be the better place to announce any further easing (both verbal and quantitative) if labour and activity data in the coming weeks continues to disappoint. Peter thinks that if we do get some form of policy change today, verbal easing is the most likely option with the extension of their “low rates for longer” into at least 2015. On balance though it looks like the Fed is still in “wait-and-see” mode. This will see the market focus build towards the Jackson Hole event at the end of the month.

On the data front the ISM manufacturing for July is expected to nudge a little higher to 50.2 from 49.7 last month. We had a slightly better than expected Chicago PMI headline yesterday (53.7 v 52.5) so market confidence for a slightly better ISM is probably higher today now. Beneath the headline, the labour component of the ISM will be important given the equivalent sub-reading for the Chicago PMI fell to a 12-month low of 53.3 yesterday. Away from the US, we will get the first read of Italian and Spanish manufacturing PMI numbers today which the market is calling for 44.1 and 40.3 respectively. We will also see if we get any revisions to the flash German manufacturing PMI which came at a 3-year low of 43.3 few weeks ago. Please see our weekly from Friday for a review of where equities are currently priced relative to the PMIs/ISM. Basically the US is broadly in line, Germany and France look expensive whilst Italy and Spain are ’cheap’ relative to the activity data.

Moving on to markets the Asian session is trading heavy overnight following continued weakness in Chinese manufacturing. The official manufacturing PMI came in slightly below expectations (50.1 vs 50.5 expected) while the HSBC ariant continues to suggest contraction in the small to medium sized manufacturing sector as the series came in at 49.3 (vs 48.2 in June). In spite of the
data, the Shanghai Composite (+0.9%) is outperforming the rest of the region as the market is seemingly buoyed by President Hu’s overnight comments that policymakers are looking at more “proactive” monetary and fiscal policy. Elsewhere the Nikkei is -1.0% lower as we type.

In terms of yesterday the market was largely guided by somewhat diminished hopes of an aggressive ECB intervention tomorrow. Comments from the German Finance Ministry suggested that we are no where closer to awarding the ESM a banking license than we were last week.

It’s worth reminding readers of the Reuters article we flagged yesterday where ECB insiders believe that “bold action is probably at least five weeks away” given several pieces are still yet to fall in place. Tomorrow is going to be fascinating. Weaker European data didn’t help sentiment either as we saw Eurozone unemployment hit a new high of 11.2% in June. German unemployment numbers also rose by 7000 in July although unemployment rate was steady at 6.8%. The Stoxx600 (-0.97%) closed lower for the first time since Draghi’s “dowhatever- it-takes” speech last Thursday.

In the US the S&P 500 closed -0.43% despite the better Chicago PMI headline. European intervention doubts offset the better US data flow yesterday. The Case Schiller home price index (+0.9% v +0.4% expected), personal income (+0.5% v +0.4% expected) and
consumer confidence (65.9 v 61.5 expected) all topped estimates. Bloomberg’s pre-FOMC survey was also an interesting data point, with just 14% of economists surveyed expecting a third round of large scale asset purchases to be announced by the Fed today.

In terms of today the ADP employment change report will be a notable US release. We have a 5yr Bund auction today but all eyes will be on European PMIs, US ISM manufacturing and the FOMC statement.

Asset performance review

As we mentioned yesterday July turned out to be a positive month for equities and credit but the star performers this past month were soft commodities (by a wide margin!). Indeed Wheat and Corn were the big winners in July as the drought in the US helped both post a
20% monthly gain. In our selected sample Wheat and Corn are also up the most in year to date terms, at +36% and +25% respectively. If these continue to remain elevated, headline inflationary pressure will likely start to mount which may complicate monetary policy easing when needed. Away from the crops, core European equities have performed well. The DAX and the Stoxx600 were up +5.5% and +4.1% respectively. Elsewhere the S&P 500 and the FTSE were also up by +1.4% and +1.2% on a total return basis. We are also reminded that the S&P 500 is up 11% for the year and has yet to fall below where it ended last year – a feat that was last seen in 1979. Moving on to Credit, total returns were positive in July but excess returns were somewhat more mixed given the mid month stresses and the solid performance in core rates. Bunds and Treasuries gained +2.1% and +1.1% in July versus the total returns of +1.7% and +1.5% seen in US and EU HY. The “losers” in July were the Shanghai Composite (-5.1%), IBEX (-4.6%) and the Nikkei (-3.5%). The EUR also depreciated nearly 3% against the Dollar. Spanish bonds lost -1.5% and the FTSE MIB lost -2.7% – all impacted by the renewed wobbles in Sovereign Europe. Clearly the last week has seen a significant rally but generally it was still a weak month for peripheral risk. Tomorrow’s ECB meeting will likely define August’s performance for these assets. A big 36 hours awaits before we even get to another payroll Friday.

Jim Reid
Strategist

Colin Tan, CFA
Research Analyst

Deutsche Bank