UK GDP shrank more than anticipated in Q1

• The UK’s economy shrank by 1.6% q/q in Q1 2021, a slightly larger decline than initially expected. Household spending dropped off considerably, by 4.6%, as lockdown measures effectively kept the economy on hold. Business investment was also affected, dropping by almost 11% in Q1 q/q. On an annual basis, the overall economy shrank 6.1% in Q1 although a strong bounceback in Q2—with market consensus at more than 22% y/y—is expected as restrictions are lifted. We still expect the Bank of England to keep policy accommodative over the rest of 2021, even if some of the language it uses to describe the recovery is more assured.
• Inflation in the Eurozone came in at 1.9% y/y for June, in line with market expectations and a modest slowdown from the 2% growth in May. Core inflation slipped to 0.9% from 1% a month earlier as underlying price pressures beyond volatile food and energy remain contained. The dip in June was largely driven by a downward tick in Germany as most other major European economies saw price growth accelerate m/m in June compared with May. The ECB has kept a similar tone to the Fed, noting the temporary nature of inflation in 2021 as a consequence of economies reopening after lockdowns in 2020 and earlier this year.
• The ADP private sector employment report showed 692k jobs added in June, a deceleration from the estimate of 886k jobs added in May. The growth was distributed across sectors, with leisure and hospitality adding more than 330k while education and health added more than 120 and manufacturing and construction were both higher. The official non-farm payrolls figure to be released on Friday is expected to come in at around 700k for June, up from the 559k added in May. Any substantial disappointment on the downside risks keeping UST yields subdued and could take some of the sting out of the dollar’s post-FOMC rally.
• The headline unemployment rate in Saudi Arabia fell to 11.7% in Q1 2021 compared with 12.6% in Q4 2020, according to the latest data available. However, the decline appears to be related to a lower overall participation rate as more potential employees dropped out of the labour market, rather than reflecting a robust period of hiring. The participation rate to 49.5% in Q4 2020 to 51.2% in Q1 2021.
• PMI numbers for Asian economies slipped in June as spreading Covid-19 cases have caused lockdowns while supply chain shortages are also affecting access to material. PMIs for the manufacturing sectors were slower in Taiwan, Malaysia and Vietnam while South Korea, the Philippines and Thailand saw some stabilization, albeit near neutral levels of activity. The Caixin China manufacturing PMI also slipped, falling to 51.3 in June from 52 a month earlier.

Today’s Economic Data and Events

08:00 ID CPI y/y June: forecast 1.45%

09:00 IN Manf. PMI June

11:00 TU Manf PMI June

12:00 EZ Manf PMI June f: forecast 63.1

16:30 US Initial jobless claims: forecast 388k

18:00 US ISM Manf. June: forecast 60.9

Fixed Income

• The US yield curve ended the quarter considerably flatter with long term USTs gaining amid waning inflation fears and market acceptance that the Fed isn’t going to be withdrawing stimulus in a hasty manner. Yields on 2yr USTs closed overnight at 0.2486%, essentially unchanged but almost 9bps higher on the end of Q1. For 10yr yields, they settled overnight at 1.468%, little changed, but down by more than 27bps from the end of Q1. The 2s10s spread flattened considerably, closing overnight at less than 122bps compared with almost 160bps at the end of Q1.
• Among other benchmark government bond markets, the moves were far less pronounced. Gilt yields on the 10yr closed overnight at 0.715%, down 2bps and off by almost 13bps on the quarter. In contrast, bund yields edged higher over the last three months: 2yr bund yields added almost 3bps to -0.667% and 10yr yields at -0.209%, up 8bps.
• Emerging market local currency bonds had a strong quarter thanks to the drop off in USD yields. In India, despite the enormous rise in Covid-19 cases earlier in the quarter and subsequent lockdowns, bonds managed to gain with yields on 10yr Indian government bonds falling almost 12bps to close the quarter at 6.048%. In South Africa, strong investor appetite for the debt helped yields move down 23bps over the quarter to 9.247% while the standout was Turkey where yields sank more than 164bps to close at 16.62%, dropping off from a surge at the end of Q1 thanks to an abrupt change in central bank leadership.
• Qatar Petroleum priced its multi-tranche issue, raising USD 12.5bn in total. A 5yr 1.5bn tranche priced at T+55bps, a USD 3.5bn 10yr at T+90bps, a USD 3.5bn at a yield of 3.15% and a USD 4bn 30yr Formosa at 3.5%. The size of the issue compared with an original target of USD 10bn suggests that investor appetite was healthy for the funds which will be used to finance LNG capacity expansion.

FX

• Despite a surge in the final weeks, Q2 wasn’t kind to the US dollar. The DXY index fell by 0.9% over the three months to close at 92.346 as the accommodative view from the Fed permeated for most of the quarter, only reversing following the June FOMC. The US non-farm payrolls and broader employment indicators will set the trajectory for the dollar in the near term.
• In contrast EURUSD managed a 1% gain over the quarter even as selling pressure has been strong in the last few week. The single currency settled at 1.1858 overnight, down 0.33% on the day. Sterling gave back much of the exuberance it showed in earlier in Q2, closing the quarter 1.3831, up 0.35%.
• Among commodity currencies it was a mixed quarter. CAD benefitted from the rise in oil prices and closed USDCAD 1.2401, a decline of more than 1.3%. For AUD the recent return to lockdown erased much of the higher commodity price and trade driven rise and AUDUSD fell 1.3% over the three months, settling at 0.7498. NZD failed to hold on to mid-quarter gains and closed at 0.6983, roughly flat on the quarter.

Equities

• In the US, a 0.1% gain yesterday meant another new record high for the S&P 500, but its gains over the month were less than the NASDAQ. The S&P added 2.3% m/m, but the NASDAQ added 5.5% m/m as tech stocks surged back, even with a -0.2% drop yesterday. The Dow Jones was the biggest gainer yesterday, closing up 0.6%, but remained down -0.1% m/m.
• Shares were under pressure in Europe due to uncertainty regarding the recovery as Delta variant cases continued to spread. Germany’s DAX lost -1.0%, while the UK’s FTSE 100 closed -0.7% lower and the CAC lost -0.9%.
• Within the region, the DFM lost -0.6% but the ADX closed 1.1% higher yesterday and the EGX 30 gained 1.3%.

Commodities

• Oil prices had a strong quarter, rising 18% in Brent markets to USD 75.13/b and more than 24% in WTI to USD 73.76. A recovering demand picture, falling inventories, risk appetite among investors and a tight supply picture managed by OPEC+ have all helped to push oil prices to multi-year highs. Market structures ended the quarter strongly in backwardation in anticipation of tighter conditions in the months ahead.
• OPEC+ meets today and we expect a small production increase to be agreed. However, the deal is likely to be fractious as splits emerge between those who favour keeping output restrained, like Saudi Arabia, and those who seemingly want to take advantage of high oil prices like Saudi Arabia. The meeting will be a near-term catalyst for oil price volatility over the next few days.
• Metals prices were positive across the quarter with gold getting a tick higher from lower UST yields. Gold prices managed to rise by 3.65% in the three months to settle at USD 1,770/troy oz but the outlook for the next quarter looks less assured as yields are likely to gain on market expectation that the Fed will announce how it plans to bring QE to an end.
• In industrial commodities some of the excess got shaken out by a stronger USD in the final few weeks but nevertheless recorded strong gains. Aluminium prices on the LME rose 14% to USD 2,523/tonne while copper prices managed to break above USD 10,000 although faded and ended the quarter at USD 9,374/tonne, up 6.7%.

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