Market update (24 May 2018)

May 24, 2018 Written by Gavin Pannu, MSTA, CFTe

Stocks fall, retreating from the record highs seen earlier in the week as traders stepped in to book some profits. Worries about relations between the US and China resurfaced after President Trump said on Tuesday that he was not happy with the progress being made on trade talks. He also said that there is a “very substantial chance” a historic summit with North Korea’s Kim Jong-Un next month may not happen.

Inflation is falling back towards 2%, as the impact of GBP depreciation fades. How fast it falls back will be an important factor for how fast the Bank of England tightens monetary policy. Not even optimism from BoE Governor Mark Carney over the outlook for the UK economy, plus the suggestion of 6 rate rises between now and 2021 from policy maker Vlieghe, was sufficient to meaningfully lift the pound.

Data from the Office for National Statistics showed that UK inflation slowed in April. Consumer prices climbed 2.4% year-on-year in April, slightly slower than the 2.5% increase seen in March. The rate was expected to remain at 2.5%. This disappointing UK inflation data – prompting fears of a delayed interest rate hike from the Bank of England.

Eurozone private sector grew at the weakest pace in one-and-a-half years in May with the rate of expansion slowing for the fourth consecutive month, flash survey data from IHS Markit showed. The composite output index dropped to an 18-month low of 54.1 in May from 55.1 in April. The score was forecast to remain unchanged at 55.1. Nonetheless, a reading above 50 indicates growth. Growth deteriorated in both services and manufacturing, down to 18- and 16-month lows, respectively. The services Purchasing Managers’ Index came in at 53.9, while the score was expected to remain at 54.7. The manufacturing PMI slid more-than-expected to 55.5 from 56.2 in April. Economists had forecast manufacturing PMI to drop to 56.1.

Due to recent soft data, market participants have pushed back their expectations about the timing of policy tightening in the UK and Eurozone, and as a result the pound and euro have both suffered.

At the start of the week stocks had risen as investors cheered comments from US Treasury Secretary Steven Mnuchin, who said over the weekend that the Trump administration would put the trade war on hold as it worked out the details of a deal with China. However, when asked about how trade talks with China were going later on in the week, US President Trump told reporters that he was not happy and that the negotiations have a long way to go.

The Federal Reserve meeting minutes stated it would be comfortable letting inflation temporarily run above its 2 percent target. Fed officials said that they’d be comfortable allowing inflation to briefly run above its target as the economy continues to rebound. Specifically, the minutes said “a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective.”

The market was bracing for a hawkish tone to the meeting minutes and what they got was a marginal dovish tone in terms of the language. The Federal Reserve continues to project two more rate hikes are on the way this year with three more on the way for 2019, according to the minutes of the most recent policy-making meeting. There was no interest rate hike at the May meeting of the Federal Open Market Committee, but policy makers debated the threat of inflation and acknowledged trade-related uncertainties.

Yet another inflammatory move from Donald Trump, with the President kicking off an investigation which could lead to the imposition of tariffs on automobiles from allies such as Japan, Europe and South Korea. This comes after FOMC minutes which cited this combative trade approach as being negative for business sentiment. With North Korea shedding further doubt on the 12 June meeting between Trump and Kim Jong-Un, it’s no surprise we have seen a risk off scenario towards the end of the week. For the most part we are likely to see geopolitical effects continue to dominate.