Over the past month, the bullish narrative has been fueled by rate cuts expectations and a first glance at solid US earnings, especially in the financial and banking sector that will benefit from upcoming softer US regulation this Autumn. The main themes of the first part of the year – trade war and China’s economic situation – are playing a less important role in the stock market. Investors are betting on a mini insurance cut cycle in the United States, that will start at the end of the month, which explains higher risk appetite. In the forex market, since early July, market makers are less active, but volatility is still present on some pairs, especially the USDGBP and to a lesser extent the EURUSD. Contrary to what most market participants believed; the EUR/USD rally was short-lived mostly due to the surprising dovish tone of the ECB. There was little doubt that the ECB would follow the path of the Fed, but no one thought it would have happened so quickly.
The macroeconomic outlook in Asia and notably in China has not changed much over the past weeks. Stabilisation of the economy continues but it is not broad-based. Further fiscal stimulus measures are certainly needed to support domestic demand in coming months.
Despite some weak spots, data confirm that China’s economy is resilient to the impact of trade war. We consider that the trade truce between China and the United States will last at least until the end of the summer, but it is obvious that there is no final trade deal nowhere in sight. The Osaka agreement was a big misunderstanding. According to people close to Chinese officials, Beijing has never made any explicit commitment to buy US farm products and saw it as contingent on progress toward a deal. As long as both countries manage to mitigate the macroeconomic effect of the trade war, the likelihood of trade agreement is close to zero. The real question that any investors should ask himself is: who can sustain the trade war pain longer? The first country that will fail will be the one that will make concessions. As of today, it is impossible to know whether it will be China or the United States.
In the United States, the latest June data were broadly better than expected which tends to indicate growth is strengthening: unemployment is near a 50-years low and way below NAIRU, inflation expectations are slowly rising, retail sales were strong for two months in a row, ISM manufacturing was out at 51.7, with production and employment growing. The weakest spot is industrial production which has moved lower again in June, at 1.3 percent YoY, as a consequence of the gloomy global trade outlook. One risk that investors will need to monitor in coming months is linked to rising inflation that could negatively impact US households’ purchasing power in a context of low wage increase.
In Europe, the outlook is more worrying, mostly because of Germany’s depressed economy. The euro area economic surprise index is still in negative territory, standing at minus 8.8 and there is no sign of improvement coming.
Looking ahead, we all know that the main market focus will be on central bank meetings at the end of the month. It will be the confirmation we are in a completely new monetary and economic paradigm where unconventional tools used after 2008 are becoming conventional tools in a world of very low neutral rates.
