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Weekly Update - 17 December 2018 (UK/Europe)

  • Global equity markets marginally fell over the week with the MSCI AC World Index returning -0.8% in local currency terms. However, broad sterling weakness pushed up the returns to 0.5% in sterling terms. Energy and Financials declined the most.
  • US-China trade negotiations saw some positive developments with China restarting purchases of agricultural products from the US and reducing tariffs to 15% from 40% on US-manufactured automobiles. On the Brexit front, UK prime minister Theresa May delayed the parliamentary vote on the Brexit deal, following which a no-confidence motion was triggered which she eventually survived. However, the margin of victory was significantly lower than expected with 117 MPs expressing no confidence. This was despite a promise by May that she would stand down before the next election.
  • The UK was the best performer in local currency terms (1.0%) whilst Developed Europe ex UK was the best performer in sterling terms (1.4%). Japan was the worst performer in both local currency terms (-1.6%) and sterling terms (-0.7%).
  • Bond yields across developed markets had a mixed performance. Both the 10-year and the 20-year UK gilt yield fell by 4bps each to 1.23% and 1.70% respectively. 10-year US treasury yields rose by 4bps to 2.89% in a week in which US inflation rose at its slowest pace in nine months.
  • In Europe, the European Central bank left its interest rates unchanged and confirmed that it would end its quantitative easing program by the end of 2018. German Bund yields fell by 1bp to 0.25%. French government bond yields rose by 2bps to 0.71%. Over the week, the spread between French government bond yields and German bunds reached its widest level since the 2017 French elections as fiscal measures introduced following recent public protests raised concerns of an increasing budget deficit in France. Italian government bond yields fell by 17bps to 2.96% after the Italian Government succumbed to the European Commission and lowered its budget target to 2.04% instead of initially proposed 2.4%. Greek government bond yields rose by 2bps to 4.23%.
  • The UK 20-year real yield fell by 10bps to -1.92% and the Over 5-year real yield fell by 5bps to -1.69%. 20-year breakeven inflation rose by 8bps to 3.55%.
  • The US high yield bond spread over US treasury yields fell by 4bps to 446bps. The spread of USD denominated EM debt over US treasury yields fell by 10bps to 390bps over the week. The sterling non-gilt spread over UK gilt yields (based on the Merrill Lynch index) fell by 2bps to 148bps.
  • The S&P GSCI fell by 2.4% in USD terms over the week. The energy sector fell by 3.5% as the price of Brent crude oil fell by 2.3% to US$60/BBL. Industrial metal prices fell by 1.0% as copper prices declined by 1.1% to US$6,104/MT. Agricultural prices fell by 0.6% and gold prices fell by 0.6% to US$1,235/Oz.
  • Sterling depreciated against major currencies over the week. Sterling depreciated against the US dollar by 1.6%, ending the week at $1.26/£ and fell 0.7% against the euro to €1.11/£. The Japanese yen depreciated by 0.6% against the US dollar, ending the week at ¥113.42/$.
  • US economic releases ended last week on a disappointing note as provisional Purchasing Managers' Index (PMI) data showed a deceleration in both the manufacturing and services sector. Both index readings missed forecasts of a 0.3-point dip to 55.0 and fell to 53.9 and 53.4, respectively – the former reaching a thirteen-month low. The poor PMI data was preceded by stronger-than-expected retail sales growth. Sales rose by 0.2% in November against consensus estimates of a 0.1% increase while October's release was upwardly revised to 1.1%. Earlier in the week, consumer prices were unchanged over November and resulted in a slight slowing in headline inflation on a year-on-year basis from 2.5% to 2.2%. Underlying inflationary pressures held firm, as reflected by the increase in core inflation (increase to 2.2% from 2.1%) but were offset by the sharp drop in energy prices.
  • In the UK, economic growth slowed to 0.4% from 0.6% in the three months to October as growth in the manufacturing sector weakened, largely driven by falling car sales, and construction growth slowed. Strong growth in IT and professional services were the main driver in the service sector. October’s industrial production disappointed with output contracting by 0.8% year-on-year after being flat in the previous month. The unemployment rate remained at 4.1% in the three months to October, meeting expectations, with job vacancies near an all-time high. However, nominal wages grew by 3.3% in the three months to October, the fastest pace since 2008, against expectations of it remaining at 3.2%. Elsewhere, the October trade deficit widened to £3.3bn from a revised £2.3bn in September as imports rose (+2.8%) by more than exports (+1.0%).
  • In the Euro Area, the Markit Services PMI declined by two points from 53.4 to 51.4 – the lowest reading since November 2014 – as new business and expectations declined to four-year lows. Similarly, manufacturing PMI slipped from 51.8 to 51.4 expectations fell to a six-year low while goods orders declined at the fastest rate in four years. German PMIs fared slightly better but still fell by 0.3 points to 51.5 for the manufacturing sector and 0.8 points to 52.5 for the services sector. Elsewhere, Euro Area industrial production bounced back from a downwardly revised 0.6% decline in September, rising 0.2% in October. Finally, the December German ZEW survey of economic sentiment rose by 6.6 points to -17.5 as Brexit and trade tensions continued to weigh on exports and private investment. The ZEW current situation survey fell sharply by 12.9 points to 45.3, well below consensus of 55.8.
  • In Japan, the Bank of Japan’s Q4 2018 Tankan survey revealed resilient sentiment in both manufacturing and non-manufacturing sectors with both outperforming expectations of a 1-point fall. The Tankan large manufacturer’s index held firm 19 and above the consensus estimates of 18 while the non-manufacturing increased by 2-points to 24. More-positive sentiment was also reflected in the Nikkei manufacturing PMI release with December's reading showing a 0.2-point increase to 52.4. However, the outlook soured for both sectors with the manufacturing outlook falling to 15 from 19, and the non-manufacturing outlook falling to 20 from 22. After September's natural disaster affected 18.3% drop, core machine orders rebounded by 7.6% in October but missed analyst forecasts of 9.7% increase.
  • In China, industrial production growth unexpectedly slowed to 5.4% for the year to November. Analysts had expected November's reading to remain at 5.9%. Fixed asset investment grew by 5.9% (year-to-date) from a year earlier, marginally beating economist forecast of 5.8% growth. In addition, retail sales growth decelerated to 8.1% over the year to November, falling short of analyst forecasts of 8.8% growth.
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