The Weekly Update

There was little excitement across markets as the ‘summer’ holidays kicked off in true British style; with rain. There were a couple of events of note, first was the BoE policy meeting, the central bank held rates and appeared more dovish than markets had expected; sterling tumbled 1.14% and 10-year Gilt yields fell 4bps over the week. The sharp move lower came off the back of revised growth forecasts; the BoE trimmed this year’s growth to 1.75%, from 1.9%, with a marginal downgrade to 1.6% for 2018. Exports are expected to be the main driver of growth and consumption the drag; resulting from sluggish wage growth. The BOE’s Carney noted that the demise of sterling was to blame for the sharp upturn in CPI readings, and the central bank expects inflation will peak at 3% by October, before moderating to 2.2% by 2020. Industrial and manufacturing production and construction releases for June may be of some interest this week, with the latter the only reading expected to see a positive reading. Also, Brexit uncertainties remain with Carney noting, ‘the assumption of a smooth transition to a new economic relationship with the EU will be tested.’

The other ‘major’ event was the US employment data dump; where 209k jobs were added in July, employment dropped a tenth to 4.3%, and average hourly earnings grew slightly to 2.5%. Having fallen ahead of the employment report, US Treasury yields witnessed a spike after the more positive data; settling 3bps lower over the week, to 2.26%. While the Fed can be considered to have reached its maximum employment goal, the price stability objective is proving much trickier with the Fed’s favoured inflation measure (personal consumption expenditure) languishing below the 2% goal. Opinion is split among committee members, with some viewing the softening in inflation as transitory and others concerned that progress towards the objective may have slowed, thus softness could persist. To us, this implies a cautious and gradual approach to any further rate rises and downside risk to the ‘dot plot’. The dollar finally enjoyed a rally after the stronger employment data was released, ending the week up 0.30%, measured by the DXY Index.

Today is a pretty quiet day in terms of key US economic data releases, Tuesday’s JOLTS job openings reading for June will be watched closely. On Thursday we’ll see a number of PPI data releases, followed by the monthly budget statement and CPI readings will grab market attention on Friday; market expectations are for an increase in core prices, to 1.7%yoy. The Fed’s Bullard and Kashkari will speak today, with Dudley following on Thursday and Kaplan and Kashkari speak on Friday. The market will be looking for further clues on Fed tapering.

Elsewhere, as US-China trade concerns ramped up last week, with no further updates on Friday as Trump’s White House address regarding China’s trade and intellectual property practices was cancelled. Meanwhile, in what was a data thin week for China, there were a number of headlines stating that the PBoC could widen the currency's trading bands, from 2% to 3%; as the currency has easily traded within the 2% band, since the fixing mechanism was reformed back in 2015, the widening impact may be limited. A government advisor mentioned that the move to widen the bands ‘may just be a gesture to express the commitment to long-term market reform.’ This week’s data prints were kicked-off by better than expected fx reserves, which came out this morning at USD 3,080.7tn in July. Imports and exports and trade balance numbers will take centre stage on Tuesday, and CPI and PPI readings are expected to come in at 1.5% (unchanged) and 5.6% (marginally higher) on Wednesday.

Last week the bond market witnessed rare issuance from Iraq. The USD 1bn, 5-year deal, came to the market at a yield of 6.75%, very attractive levels for those on the hunt for yield; so much so that the bond was reportedly 7 times oversubscribed. The deal was also brought to the market by high tier global investment banks: Citi, Deutsche Bank and JPMorgan. Although the country sits on the world's 5th largest hydrocarbon reserves and has an NFA score of 3 stars, this issue is not one for us. For starters most readers will be aware that we favour investment grade bonds across our portfolios; this bond is rated B- by Fitch, and S&P rates the country B-. Next, using our proprietary Relative Value Models, we calculate that this bond at issue was actually expensive. Issued at a spread of 493.10bps over Treasuries, that may seem like sufficient cushion for what most would call a war-torn and highly unstable country’s debt. However, we calculate that bonds with a similar rating and duration trade at ~557bps over; implying that the bond was priced 0.60 credit notches expensive. We expect little in the way of new issuance over the next few weeks with most of the market out on holidays.

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