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Investment Bank

Investment Bank

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Last week / This week 

Aziz Sunderji, Zoso Davies, Juan Prada
 

  • Amid stable equity and bond markets last week, the standout moves were the weakening of the US dollar against a broad range of currencies and the selloff at the long end of the US Treasury curve. The clearest macro theme was the continuing divergence of the US and Chinese economies. 
  • In the US, we revised our estimate for second-quarter GDP growth to 5%. Strong US retail sales and a solid rebound in industrial production signaled a meaningful acceleration in activity in Q2. Concerns about tariffs have increased among US households and business, but for now, fiscal stimulus is providing a significant buffer against the effects of protectionism. While trade looks set to make a significant contribution to growth, we see this as transitory and expect it to be reversed in the second half as the trade deficit widens. 
  • If the US is chugging along, why is the yield curve flattening? We believe the yield curve is signaling that policy is about to become restrictive and would move significantly into restrictive territory if the Fed continues to hike next year. Whether that means that a recession is around the corner is up for debate. Our clients believe there is information in the curve about the risk of a recession: if it inverts to below -25bp, they think the risk of recession rises to 50%. 
  • In China, the authorities are finding it difficult to balance the two objectives of delivering strong growth while gradually deleveraging to reduce financial stability risks. On a q/q basis, Chinese GDP growth slowed notably in Q1. We see downside risks to growth forecasts arising from the government’s “structural deleveraging” campaign and a further escalation of the trade war. In view of the delicate balancing act required, we think the government is willing to fine-tune some policies to prevent systemic risks or a market panic. The new easing moves by the PBoC and CBIRC to boost SME lending confirm that a more coordinated policy response is underway. 
  • Looking to the week ahead, the key events are the “flash” composite PMI readings from Europe on Tuesday, which should show services supporting growth; and trade data from the US on Thursday. We expect the goods deficit to widen amid moderating export growth. The ECB meeting is also on Thursday. We forecast no policy changes, but expect the Q&A session to provide some clarification about the ECB’s position on recent developments in inflation, growth and trade wars. Tokyo CPI data will provide the final inflation read before the 30-31 July MPM, where the BoJ is widely expected to lower its CPI forecasts. Weekend news reports suggest the BoJ will also discuss policy tweaks to deal with side effects of its current policy. Market moves on Monday (JPY stronger, equities down) suggest renewed expectations for normalization. We discuss the news, including market implications, but retain our outlook for normalization to begin in April 2019 in this report. 
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