As we begin to think about a new week, last week’s sharp sell-off in emerging market assets, developed market equities, particularly tech stocks, remains in focus. Although risk sentiment had picked up by the end of the week, it highlights a fragility in the markets, and this could be the first of many risk off moments for the markets in the coming months.
Focus turns to fundamentals
This week economic fundamentals are back in focus. Friday’s US labour market report, which had not been released at the time of writing, could set the tone for global markets at the start of the week. The market is expecting a decent reading of nearly 200k for NFPs, and a further drop in the unemployment rate to 3.8%, along with a decent 0.2% rise in wages for August. Anything stronger than this could drive the dollar higher, which may trigger a wave of selling in emerging market assets. The South African rand, Brazilian real and Turkish lira, where politics and high levels of USD-denominated debt dominate, could be particularly at risk.
Watch out for the central bank deluge
The key focus in Europe will be Wednesday’s ECB meeting and Thursday’s Bank of England meeting. The focus for both meetings may be less on policy and more on the successors for the heads of both central banks. The ECB’s Mario Draghi’s term is up next year and already German politicians have said they want someone who will end the ECB’s QE programme and return policy to more normal levels – read an abrupt end to QE and higher interest rates. Although unlikely to be addressed during this week’s meeting, it will be interesting to see if Draghi stands firm and pledges to only adjust policy at a slow and steady rate, which is the current policy, in the face of German criticism. Draghi could justify a softer tone on the back of a notable slowdown in Eurozone data, including weaker PMI reports, and German industrial data, which may weigh on the euro.
Italy: the canary in the coalmine?
The ECB governor is also likely to be asked about Italy and its upcoming budget, especially as there is a risk that Draghi’s homeland could flaunt EU budgetary rules in order to fulfil election promises of both lowering taxes and simultaneously raising public spending levels. In the past, Draghi has said that governments need to do their bit to get their financial houses in order and not rely on the ECB as a backstop for financial support. If he says something similar this week it could trigger some nerves about the future for Italy, which may weigh on the euro, push up Italian bond yields and cause selling pressure on Italian bank stocks.
Brexit = problems for the pound
No change is expected by the BOE this week and we will not hear from Mark Carney, so we expect Wednesday’s meeting to pass without too much impact on UK asset prices. However, the BOE Governor Mark Carney is talking in Dublin on Thursday and this is where things could get interesting. Will he hint that he will stay on as governor past 2019? Will he state how worried the BOE is about Brexit risk? Will he lay out the BOE’s plans for policy support in the case of a disorderly Brexit? Or will signs that Germany and the UK will reach a Brexit agreement be enough to leave him confident about the UK’s economic future outside of the EU?
These questions could have big implications for UK asset prices. Right now the focus for the pound is Brexit, signs of a deal = pound goes up, signs of no deal = pound falls. We don’t expect this pattern to end until a Brexit deal is signed, sealed and delivered, or not, in the coming months. This is the chief reason why the pound is the third most volatile currency in the G10 this year, behind Sweden and Norway’s currencies. $1.30 in GBP/USD continues to cap the upside, and if GBP/USD makes a concerted break above this level this week, unless we see a solid and fundamental shift towards a Brexit deal that suits the UK, then we would expect the pound to be sold on any rallies.
Economic round up
Elsewhere, watch out for Japanese GDP, Chinese retail sales and industrial data, UK labour market data and industrial production, Eurozone final Q2 GDP and German ZEW surveys, along with US CPI and retail sales. It’s a busy week, good luck trading.