Macroeconomic update: Chinese growth normalisation, markets fixated on Fed rate cuts

Summary:

• Chinese Q2 GDP growth meets forecasts, a package for June comes in above expectations
• Solid prints from the US (retail sales, regional Fed indices), weaker from the housing market, market participants still expect rate cuts
• ECB considers changes to its inflation target, EURUSD trapped in range trading

A bag of data from China eases global growth concerns

The Chinese economy keeps normalising its economic growth. Source: Bloomberg, XTB Research

Although the Chinese economy grew 6.2% in annual terms in the second quarter, matching expectations, it was the slowest pace of economic expansion in almost three decades. However, when it comes to China we think that GDP is not among the highest priority readings. The economy keeps moving toward its sustainable growth level (nobody knows where it is) after years of double digit GDP, hence one cannot be surprised with the current (very smooth) pace of slowdown. Instead zooming in on GDP numbers, we prefer to look at trends built on monthly indicators like retail sales or industrial production (the chart above). Of course, we did have a slowdown in all three categories but we think this has been a natural process in terms GDP growth normalisation. Three conclusions can be drawn here. First, fixed assets investment has stabilised over the recent year and we have yet to slide below 5% (3MMA). Second, industrial production has also normalised since 2015 slightly above 5% and we have yet to see a negative impact of increased concerns about China’s growth lately. Third, retail sales have stood out in recent years being more resilient than the two above-mentioned series. In our view this is the effect of efforts undertaken by the authorities in recent years to make the economy more consumption rather than export-oriented.

Markets disregard solid US data being fixated on Fed rate cuts

The Citi Eco Surprise Index seems to have bottomed out after reaching one of the lowest points this decade. Source: Bloomberg, Research

Investors were offered solid prints from the United States regarding retail sales this week. The June report showed headline sales rising 0.4% MoM, core prices (ex auto and fuel) climbing 0.7% MoM, well above expectations. Thus, the entire quarter saw a solid and stable pace of retail sales increase boding well for private consumption (Q2 GDP will come out next week). At the same time, we got solid rises of regional Fed indices while industrial production for June came in subtly below expectations. In fact, the sole disappointment came from the housing market with both building permits and housing starts slowing much more than forecast. Overall, we still do not see the strong case for deep Fed rate cuts, however, some Fed officials (see the latest speeches of Williams and Clarida) seem to back up such a preemptive approach. All in all, markets appear to disregard of better data being fixated on rate cuts and thereby paying attention only to worse prints. Anyway, a 25bps rate cut is a done deal and we think the Fed could struggle to surprise markets in a way to see the weaker greenback unless it delivers a 50 bps cut, a move which would be ridiculous.

ECB mulls over changing its inflation target policy

The EURUSD keeps trading within range treading between 1.1280 and 1.12. Source: xStation5

The news brought by Bloomberg yesterday that the ECB is mulling over changes to its inflation objective policy was a shocker for markets, at least to some extent. The ECB is reportedly considering to revamp its inflation goal to be more symmetrical. In practice, it means the ECB would tolerate even higher inflation, and be legally allowed to take a wait-and-see approach even if price growth exceeds 2%. If such a change is implemented it would have serious ramifications for the ECB monetary policy being a drag for the common currency. As a consequence, market participants could not be willing to bet bolder on the euro until they are offered more clarity on this topic. As such, the EURUSD could be still trapped within quite a narrow range for the time being.