Week In Focus; week commencing 8 October 2018

Sunday: Brazilian Election

Monday: Chinese Caixin Services PMI, Eurozone Sentiment Index

Tuesday: Japanese Current Account

Wednesday: Australian GDP, US PPI, UK Monthly GDP, Production & Trade Balance

Thursday: US CPI, Japanese PPI, ECB Minutes

Friday: Eurozone Industrial Production, Chinese Trade Balance, Pastor Brunson court decision, US Banks kick off US earnings season

ITALIAN BUDGET

Last week saw a relentless slew of updates from Italy in what was a frantic week for Italian assets as Italian policymakers unveiled their deficit/GDP targets for 2019-21. In terms of the specifics, after various ‘source reports’ throughout the week, the Government eventually announced a 2.4% deficit/GDP target in 2019, 2.1% in 2020 and 1.8% in 2021. This was broadly interpreted as a market positive given fears in the market that the Italian government could have pressed for 2.4% for 2020 and 2021. That said, one of the main bones of contention remains the Italian government’s GDP forecasts which underpin the targets. The latest estimates reveal that the government are reportedly looking at GDP Growth of 1.5% in 2019, 1.6% in 2020 and 1.4% in 2021. However, such forecasts have been met with great cynicism by the market and EU officials and subsequently have stoked fears that Italy’s eventual deficit/GDP level could come in above the targeted levels and possibly breach the European Commission’s 3.0% threshold. In terms of scheduled events, October 15th is the deadline for Italy to submit their proposal to the Commission, however, ahead of that date, next week will likely see further inflammatory headlines from within the Italian Government (Deputy PMs Salvini and Di Maio vs. economy minister Tria) and against the EU as both sides jostle to advance their causes. Furthermore, markets could be bracing themselves for further turbulence in Italian assets with Salvini last week stating that Italy will not take a step back on the deficit targets even if the German-Italian 10-year spread widens to 400bps, thus highlighting the populist government’s apparent disregard for financial markets.

ECB MINUTES

As was the case with the July meeting, September’s policy announcement delivered little in the way of fireworks with the governing council’s statement broadly unchanged from the prior release. The press conference saw Draghi note that incoming data confirmed the Bank’s previous assessment that growth is broad-based, inflation is rising and the strength of economy supports confidence. In terms of the latest economic projections 2018 and 2019 growth forecasts were lowered to 2.0% and 1.8% respectively with all other projections maintained. As such, this aspect of the release will likely garner little attention from markets this time around. Instead, markets once again might instead opt to focus on whether there was a more detailed discussion on the Bank’s reinvestment policy; something which Draghi stated was not discussed but will be a topic of discussion at one of the meetings before the year-end (note, Draghi’s account of proceedings can differ from the official account). Furthermore, markets are still eager to pin the Bank down on a precise timing for the next rate hike but are likely to be left disappointed by this month’s account. Finally, there might have been some discussion regarding the risks surrounding Italy but such discussions could be considered stale by the market given that the meeting was 4 weeks ago.

UK DATA

Next week’s data slate in the UK sees a busy Wednesday with monthly GDP and production metrics all due for release. Kicking off with the growth figures, August data is expected to see Y/Y growth slip to 1.5% from 1.6% and M/M decline to 0.1%. Ahead of the release, analysts at RBC note “Lead indicators suggest that growth remained positive into August; the composite PMI remained comfortably in positive territory, retail sales slowed but still posted an expansion”. The Canadian Bank goes on to suggest that “With the three month growth rate still capturing some of the weakness from the spring in the denominator even a mild expansion in August will be enough to maintain GDP growth at 0.6% 3m/3m”. On the production front, broad consensus looks from little in the way of deviation from the priors in what can sometimes be a volatile data set with Oxford Economics previewing the release by forewarning “there remains a wide divergence between the very soft official manufacturing output series and the firmer picture from the business surveys” adding “although the business survey data has weakened a little of late and it remains to be seen whether the gap will be closed by the surveys continuing to soften or the official series stepping up”.

US CPI

US headline consumer price inflation is seen rising by 0.2% MM in September, and 2.4% YY falling from 2.7% YY in August. The core measure is seen rising 0.2% MM, and rising to 2.3% YY from 2.2% previously. RBC’s analysts note that medical care prices slipped for the second consecutive month in August, and along with the fall in clothing prices, contributed to a 0.1ppts decline to the MM print. “Given the significant volatility exhibited in both the medical care and apparel components recently, don’t be surprised if we get some significant retracement of this weakness in the forthcoming report,” RBC says, adding that this may lift the core MM figure by slightly more than the consensus view.

BRAZILIAN ELECTION

According to the latest polling, right-wing Jair Bolsonaro of the PSL party is in front, followed by left-wing Fernando Haddad of the PT party (the party of former Presidents Rouseff and Lula). HSBC’s analysts say they expect both to make it through to the second round, which may bring a market neutral impact in the first round of elections on 7 October. However, the second round on the 28 October could be more choppy depending on who wins. Key will be candidates’ positions on fiscal policy and how these evolve between the first and second rounds. Bolsonaro’s economic advisor is a US educated economist, Paulo Guedes, who is supportive of market-friendly policies and reduced fiscal spending, which HSBC says could see the BRL strengthen by between 5-10%. On the other hand, Haddad brings risks of unorthodox economic policies and higher government spending; HSBC sees BRL potential downside by of around 5-20%, with domestic bond yields selling off by 100-200bps in the event of a Haddad win.

US EARNINGS SEASON

Blended S&P 500 earnings growth – which includes the few actual reported earnings, as well as forecasted earnings growth – is seen rising by 21.5% in Q3 2018, according to Reuters. Blended revenue growth is seen at 7.4%. The energy sector will likely be the ‘star’ of the season, and analysts look for earnings growth of over 100% on the quarter. Utilities and real estate are likely to be the laggards, with earnings growth seen at below 5% for both sectors. FactSet notes that analysts made smaller cuts than normal to EPS estimates in Q3, with the bottom-up eps estimate falling by 1.1% (in dollar terms, from USD 41.00 to USD 40.54) – that compares to an average decline of 3.2% per quarter over the last 20 earnings seasons. But FactSet notes that a larger number of S&P 500 companies have lowered the bar for earnings in Q3 relative to recent quarters. Of the 98 companies that have issued EPS guidance for Q3, 74 have reported negative EPS guidance, while 24 were positive; in percentage terms, that represents 76% (74/98), which is above the 5-year average of 71%. Because of the aggregate downward revisions to revenue estimates, the estimated YOY earnings growth rate has fallen from 20.4% at the end of Q2 to 19.3% this week, FactSet said. For revenue growth, this has declined to 6.9% from 7.4% on the same basis. The largest declines have been in the energy and consumer staples sector. Currently, the 12-month forward PE ratio is around 16.8, according to FactSet’s data, above 5-year and 10-year averages. Looking ahead to Q4, analysts see double-digit earnings growth, and additionally see double-digit growth in 2019 H1.

PASTOR BRUNSON

Aside from events in Brazil, focus in the EM space could shift towards events in Turkey with the latest court hearing for US Pastor Brunson scheduled for Friday 12 October. Last week, Brunson’s lawyer submitted a request to the Turkish constitutional court to release the Pastor from house arrest on the basis that his rights to freedom had been violated. Despite the issue currently not receiving as much press attention as it did in August, should the Pastor be denied his release once again, it could provide the catalyst for further woes for the TRY. Since August, the CBRT surprised markets with an aggressive 625bps rate hike despite the wishes of President Erdogan. However, the domestic economy remains in a fragile state with national Y/Y CPI now at a staggering 24.5% and the nation’s current account deficit remaining a cause for concern for investors. As such, should the court decline the request put forward by Brunson’s lawyer, this could prompt a retaliatory response from the US once again or at least serve as a reminder to markets, the risks surrounding the Turkish economy. Should Brunson be granted a release, any reprieve for Turkish assets may be short-lived given the fragility of the nation’s economy.