Independent Australian and global macro analysis

Friday, November 16, 2018

Weekly note (16/11) | Brexit turmoil adds to uncertainty

It was another week where heightened volatility was a key theme across global financial markets, which was driven by an array of geopolitical and macro event risks. The most prevalent was the unfolding turmoil relating to the draft Brexit proposal for the UK to split with the European Union (EU). 

Early in the week, the UK and EU had agreed to the wording of a proposed Brexit deal 
including the major point of contention to avoid border controls between Northen Ireland (UK) and Ireland (EU). Markets were cautious over what was to play out given that the proposal firstly needed the support of Prime Minister Theresa May's Cabinet, and then the Parliament. 

The Cabinet would give tentative approval but in a dramatic postscript, several government ministers announced their resignations on Thursday over the details of the proposed deal, which was triggered by Brexit Secretary Dominic Raab who had been closely involved in the negotiation of the draft agreement. PM May remained defiant on the deal that aims to maintain close ties with the EU, but now faces the threat of a leadership challenge and the broader possibility of the UK leaving the EU with no deal or even another referendum.

The market reaction saw the Pound knocked down heavily by more than 2% against the US dollar and yields on UK government bonds were cut to multi-month lows as expectations for future Bank of England interest rate rises were scaled back. A weaker Pound, however, saw the UK's FTSE100 equity index close near flat on Thursday. These sharp moves did not generally extend to non-Brexit related markets. 

Also in Europe, Italy re-submitted its budgetary proposal for 2019 where it maintained its plans increase its deficit despite being in breach of EU rules. The only revision that was made was a plan to reduce debt more sharply through additional privatisation of state-owned assets. While it is unclear how the EU will respond to Italy's defiance, markets drove Italy's 10-year government bond yield to 3-week highs and widened the spread to the safe-haven 10-year German Bund.  

Also in focus in the early part of the week was plunging oil prices, with crude oil recording a run of 12 straight declines — its longest run of losses on record — in response to a highly complex range of competing forces between increased output based on seemingly misplaced expectations for future prices against a slowing in forecast global demand next year, in line with a softening outlook for global economic growth.

The weakness in oil prices together with concerns relating to the financial sector hit US equity markets, which endured a run of 5 consecutive declines that was eventually halted on Thursday. Staying in the US, Federal Reserve Chair Jerome Powell maintained confidence in the growth outlook for the domestic economy but was slightly cautious around the impacts of trade tensions, fading fiscal stimulus, and financial market volatility. Regarding trade, comments from President Trump were welcomed by markets on Friday, indicating that further tariffs on China may not be imposed. Talks between the US President and China's President Xi scheduled for the upcoming G20 Summit will be a key focus for markets.       

Amid this backdrop, the local S&P/ASX200 benchmark equity index fell sharply this week by around 3.2%, with heavy declines across the industry sectors. Financials fell most (-4.6%) and the resources sectors were also under heavy pressure with Materials -3.1% and Energy -2.3%.      

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On a busy Australian data calendar this week, the labour market was the key focus. In October, total employment increased by 32,800, which was well ahead of the consensus view for an increase of 20,000. This continued the strengthening momentum seen in the labour market data over recent months. The most positive aspect of the report was that the nation's unemployment rate consolidated at 5% — its lowest level since April 2012  which eased concerns that the sharp decline from 5.3% to 5% last month may have been overstated by statistical volatility. 

Meanwhile, despite easing this year, employment growth ticked up to 2.5% on an annual basis in October. As our chart of the week highlights, strong employment growth over the past year or so has been a key factor in bringing the unemployment rate down, even as workforce participation remains around historic highs. 

Chart of the week

The downside was that spare capacity continues to remain at historically elevated levels and this is restricting an acceleration in the pace of wages growth (For our analysis of the October Labour Force Survey click here).    

This was confirmed in Wednesday's Wage Price Index data for Q3 (see our note here). Wages growth matched the market forecast in Q3 (+0.6%q/q and +2.3%Y/Y), but this was boosted by a stronger-than-normal increase to the national minimum wage that applied from the start of the quarter, while wages growth in the private sector continues to lag at 0.6%q/q and 2.1%Y/Y. Overall, there has been a gradual lift in the pace of wages growth over recent quarters, and the current annual pace, while subdued, was the strongest since Q1 2015. 

There were also updated surveys on business and consumer sentiment released this week. NAB's Business Survey was mixed in detail, with an easing in both confidence and conditions in October. Both measures appear to have moved past their peaks from earlier in the year but still remain above average. The forward-looking indicator for orders has slowed sharply compared to the first half of 2018, which matches with recent softening in other measures of business activity. Meanwhile, employment conditions were consistent with jobs growth continuing at around 20,000 per month according to NAB Analysts, a figure that would be sufficient to maintain downward pressure on the national unemployment rate.  

Westpac's Consumer Sentiment measure posted a surprise lift in November to 104.3. This was the 12th straight monthly read above the 100-level that separates optimists and pessimists. The detail showed that consumers were more confident about their own finances and the broader economic outlook, but this did not translate into an intention to increase spending. Consumers expect house prices to continue to decline, but given affordability concerns over recent years sentiment towards purchasing property posted a sharp rise in the month and is at its strongest level since March 2015.