Today’s podcast

https://soundcloud.com/user-291029717/stronger-earnings-surprising-gdp-but-no-grand-deal?in=user-291029717/sets/the-morning-call

Overview: You shoot me down, but I won’t fall; I am titanium

• US GDP beats expectations driven by strong consumption
• USD firmer in response and also supported by Kudlow’s comments of the US had “ruled out” FX intervention
• But, Core-PCE Deflator softer (1.5% y/y) and yields are little changed overall
• AUD close to breaking through 0.69; GBP also weak on growing hard-Brexit fears
• Busy week ahead: Aussie Q2 CPI, FOMC, CH PMIs, US ISM and Payrolls

Titanium features highly in my workout beats playlist and its lyrics of “you shoot me down, but I won’t fall, I am titanium” is an apt description of the US economy at the moment. On Friday US Q2 GDP beat expectations at 2.1% annualised against 1.8% expected, while the y/y figure was 2.3%. The case of the US economy remaining the least dirty t-shirt in the laundry basket remains – as reference Q2 Eurozone GDP on Wednesday is expected to be a more meagre 1.0% y/y. The USD was stronger across the board in response with DXY +0.2%, helped along by Kudlow’s comments of the US having “ruled out” FX intervention (Trump though added a layer of ambiguity, stating “I didn’t say I’m not going to do something”). The AUD was one of the weaker G10, down -0.5% close to breaking through 0.69 being at 0.6907. GBP was also weak, down some -0.5% to 1.2381 on growing hard-Brexit fears. Yields though were little moved (US 10yr -1.1bp to 2.07%) , with US Core-PCE inflation softer than expected (1.8% annualised v 2.0 exp; but importantly is 1.5% y/y) and weakness in Business Investment keeping alive prospects of an extended Fed easing cycle.

Delving into the GDP figures in detail reveals Consumption being the main driver with Personal Consumption +4.3% annualised, up from the subdued 1.1% pace in Q1. GDP growth though was dragged down by weakness in business investment (-0.6%), net exports (-0.7%ppts) and from inventories (-0.9ppts). There were also sizeable revisions to the GDP report which serves as a reminder that these figures are far from gospel – 2018 growth was revised down to 2.5% y/y instead of the initially reported 3.0%, while 2018 Q4 growth was revised sharply lower to 1.1% annualised instead of the 2.2% initially reported. Adding to the softer gloss was a below expected Core-PCE deflator which was 1.8% annualised and below the 2.0% expected. In year-ended terms core inflation is running at a meagre 1.5% and below the Fed’s 2% inflation target.

US profit reporting season also continues to show strength. Of the nearly 40% of companies to have reported so far, over 75% have beaten expectations, and Alphabet was out on Friday with its stock up some 10% after beating expectations and announcing a share buyback. The end result is that despite global growth headwinds, the S&P500 and the Dow have hit new record highs – S&P500 +0.7% to 3,026. Note Australia’s profit reporting has kicked off with Rio Tinto due to report on Thursday.

Chinese Profits out on the weekend has kept alive global growth fears with Industrial Profits -3.1% y/y, well down from last month’s +1.1%. The slowdown in profits lines up with the soft producer prices seen earlier in the month and also suggests margins are being impacted by the US-China trade war. The details show Computer & Electronic production profits ‑7.9% y/y, though there was some strength in profits for Machinery and Construction Materials – a sign perhaps that stimulus is gaining traction. In line with some official commentary of reining in iron ore prices, profits for Iron Smelters was -21.8% y/y. Given such an outlook, it wouldn’t be a surprise to see further headlines of China investigating the iron ore price and also perhaps further industry consolidation.

Hard-Brexit fears continue to sink Cable, with GBP -0.5% to 1.2382 and around the lowest levels since March 2017. Prime Minister Johnston has said he intends to deliver Brexit “by any means necessary”, while Gove told the Sunday Times that the government is working on the assumption of a no-deal Brexit. Betting markets currently ascribe a 36% chance of a hard-Brexit, up from 30% on Friday. While we continue to hold the view that Parliament remains opposed to a no-deal, until we see Parliament baring its teeth with a meaningful majority GBP looks like it will trade weaker through the Summer (31 October is the current Brexit date).

The AUD remains on the backfoot, down -0.5% since Friday and is -1.9% over the week to 0.6910. Driving the weakness is  a combination of USD strength (DXY +0.8% over the past week), alongside reaction to Governor Lowe’s speech on Wednesday which gave implicit forward guidance that rates were going to be low for an extended period of time and the RBA is willing to cut again, while its commitment to the inflation target at a time of subdued global inflation implies further easing could be on the table.

Finally, the tentative stabilisation in the Australian Housing Market continues with Auction Clearance Rates at 71.2% compared to 55.6% this time last year. The total volume of auctions though remains lower with 1,115 auctions compared to 1,536 this time last year.

Coming up today

It is a quiet day ahead with no major data releases scheduled (Japan has Retail Sales and the US the Dallas Fed Manufacturing Index). US-China trade talks restart today, though expectations are low with White House Economic Advisor Kudlow stating “I wouldn’t expect any grand deal” and President Trump implied he is going to stick to his hard line stating: “I think China will probably say let’s wait. It’s 14, 15 months until the election….I’ll tell you what, when I win [the 2020 election], like almost immediately they’re all going to sign deals. They’re going to be phenomenal deals for the country.”

Coming up this week

It is a very busy week ahead with Wednesday shaping up to be a key focal point with a likely US Rate Cut and Aussie Q2 CPI:

• FOMC meeting (Wednesday): The US is widely expected to cut rates by 25bps on a combination of international headwinds and on persistently below target inflation. The messaging in the post-meeting Statement and the Press Conference will be key and will help markets determine whether the rate cut is just an “insurance cut”, or Fed is embarking on a full easing cycle as the market currently prices in. Given the better than expected GDP numbers on Friday, those in the FOMC who are framing in in terms of an “insurance cut” may find a greater voice and there may also be a dissenter or two.
• US ISM Manufacturing (Thursday) and Payrolls (Friday): The US ISM Manufacturing will be very important given the fairly robust GDP numbers on Friday that showed softness  on the business-side of the economy. If the ISM failed to bounce, then there is a risk that manufacturing weakness starts to weigh on firms’ investment and hiring decisions in coming quarters. The Payrolls figures will also be closely watched for Average Hourly Earnings with growth in recent months topping out with the 6-month annualised now running at 2.7% compared to the 3.2% pace at the beginning of the year.
• Chinese PMIs (Wednesday): The PMIs will be important in trying to gauge how the economy is weathering the trade war. Markets expect a broadly flat outcome, though last month’s print did see a spike in New Orders for Construction and the Steel Sector which provided a strong signal for the better than expected Industrial Production and Fixed Asset Investment figures that resulted in June.
• Australia Q2 CPI (Wednesday): All focus on the RBA’s preferred measure of core inflation – the Trimmed Mean – with markets expecting 0.4% q/q and 1.5% y/y which would be below the RBA’s SoMP forecast  Headline 0.5% q/q which would take the annual to 1.5%. The more important Trimmed Mean Core Measure at 0.4% and 1.5% y/y and slightly below the RBA’s May SoMP forecast of 1.6%. Any miss on the headlined would likely increase market pricing for an August cut, currently around 20% priced.

Market prices

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