Data and the Virus may Determine the Magnitude of the Dollar’s Bounce

There is no reason to expect the investment climate is going to change next week.  The key drivers remain the same.  The resurgence being seen in the virus is posing a speed bump in the re-opening and recovery process.  The work of monetary and fiscal policy is not over.  The low real and nominal interest rates are encouraging risk-taking by savers, and this means equities, commodities, and emerging markets.  Gold, which is often perceived as a safe haven, appears more driven by the low nominal and real interest rates than fear.

In this environment, the dollar thas fallen out of favor.  There is a run against the dollar, the likes of which have not been seen for several years.  Sterling’s record-long ten session-advance was halted ahead of the weekend by late profit-taking. The euro has rallied for six consecutive weeks.  The dollar fell to 20-week lows against the yen, which was the second-worst performing major currency in July with about a 2% gain, ahead of the Canadian dollar’s 1.2% rise. 

Nevertheless, the price action and pendulum of market sentiment has swung hard against the dollar, and some consolidation (correction) is likely near-term.  As key levels are approached, like $1.20 in the euro, CHF0.9000, and $0.7200 in the Australian dollar, risk-reward calculations may change for speculators. US corporates with foreign currency receivables will be eager to lock in levels for some other exposure they may have fantasized about two months ago and do not want to miss such a godsend.  The economic data and the course of the virus may help determine the length and magnitude of this dollar bounce.  

The new monthly cycle of high-frequency economic data begins.  However, the preliminary Markit Purchases Managers Index does such a good job that it steals the thunder from the final report. It is true that there are not preliminary estimates for many countries, so there is new information in this week’s figures.  While Markit does not publish a preliminary estimate for Spain and Italy, for example, its aggregate estimate is still fairly accurate.

Maybe the US is an exception in the narrow sense that a time series that has a longer history than the PMI for manufacturing remains closely tracked.  But even here, as one would expect, the two gauges track each closely, and the PMI has the first-mover advantage.  While the manufacturing sector recovery seems on track, we are concerned that the setback in containing the virus may weigh more on the service sector.

US highlights are auto sales and the national jobs report.  Auto sales are reported over the course of the day and often seem to lack market attention.  Yet, it provides fresh insight into consumption two weeks before retail sales and can have implications for production.  Auto sales bottomed in April at a seasonally adjusted annual pace of about 8.6 mln.  It rose in May and further in June to around 13 mln. In H1, the US sold almost 13.2 mln vehicles (SAAR).  In the first half of 2019, it sold nearly 17 mln.  Auto sales are gradually picking up, and this bodes well for the continued recovery of auto production and manufacturing more broadly.

This may be seen in the employment data at the end of the week as well.  Although overall job growth is expected to slow to around 1.75 mln after a 4.8 mln jump in June, and manufacturing jobs are expected to increase to 375k from 356k.  The US lost around 1.36 mln manufacturing jobs in March and April.  If the July figure comes out as expected, then about 9.80 mln workers have returned.  That is about 72%.  Overall, if the forecast is right, then the US in the three-month recovery filled 9.3 mln positions after losing 22 mln or recouping so far around 40%.

On the other side are government jobs, likely state and local governments that are hemorrhaging, and teachers, like fell sharply.  Economists are penciling in around 450k loss of government jobs in July. In July 2019, the government sector lost about 35k jobs. That said, with weekly initial jobless claims up two consecutive weeks, and continuing claims rising at the end of the month, the risk of disappointment seems palpable. An outright net loss of jobs would be shocking, but given the volatility, the difficulty forecasting, and the rise in weekly claims, it cannot be entirely ruled out.

These figures are generated from a survey of businesses (hence the establishment survey).  ADP’s estimate of private-sector payrolls was not a very indicator of the national statistics on a month-to-month basis, but it did catch the broader trend.  However, after the couple million revision to its May estimate in early July, it may have been put in a penalty box of sorts.  The unemployment rate is determined by a survey of households and lends itself to some category errors that seem to understate the real rate.    The takeaway is the unemployment rate is still north of what was experienced at the nadir of the Great Financial Crisis, and the PCE deflator, which the Fed targets at 2%, was at 0.8% in June, below the halfway mark.

From the Fed’s point of view, now is not the time for half measures.  Yet, the federal government is struggling to agree on the next stimulus measures, and some, like the $600 a week unemployment insurance and the moratorium on evictions from federal housing, expired.   The Democrats are pushing for a larger effort, but the issue is not only money but the liability of employers for COVID-related costs of returning workers.  It is difficult to establish a causal connection, of course, but the inability to reach an agreement may have weighed on the US dollar and interest rates, pushing on an open door, so to speak. 

At the same time, a constitutional crisis may have begun brewing, though we suspect nothing will come of it.   President Trump’s suggestion that postponing the November elections until in-person voting is safe should be considered, and Secretary of State Pompeo proffered that the Justice Department has the authority to make the call.  There was a quick rejection by Senate Majority leader McConnell and other leading Republicans, and likely provided campaign material for Democrats. Biden is expected to announce his running mate next week. The election moves within the three-month horizon next week, and this is often the window of time that such events begin to be market factors.     

As the Federal Reserve acknowledged, the evolution of the virus will determine the course of the economy.  This has broad applicability.  Until there is a vaccine that is widely available, flare-ups seem inevitable.  The issue is how long it takes to bring it back under control.   Even without new national lockdowns, the economic impact can be palpable.  It may provide a speed bump of sorts to the pace of the recovery.

China’s trade figures may show a different kind of speed bump.  As the official PMIs showed at the end of last week, the recovery in recent months that Beijing reported stalled.  And part of the reason it stalled is that foreign demand has not returned.   July exports likely turned back down after popping up by 0.5% year-over-year in June.  Imports are likely to prove more resilient.  They rose by 2.7% in June and likely remained positive on a year-over-year basis.  China may be building inventory in some commodities.  Reports suggest that China has also accelerated its imports of US agriculture products in recent weeks. Through the first half, it appears China has only about 25% toward meeting its purchases of US goods.

China’s monthly trade surplus reached a record of $63 bln in May and fell to $46.4 bln in June.  The import and export forecasts point to a narrowing of the trade surplus to around $42 bln in July.  Often times, the terms of trade (export prices vs. import prices) are not taken into account when evaluating trade balances.  Yet, assuming two products: manufactured goods and commodities, with China exporting the former and importing the latter, the discrepancy in prices may also flatter the surplus.  A proxy for commodities, the CRB index is still off around 20% this year after the 40% rally since the April lows.

China is the biggest trading partner of many countries, and its trade flows offer broader insight into the state of the world economy.  It is also among the first countries to report July trade figures. Australia is reporting June trade figures next week.  They offer a timely reminder of the importance of prices, not just quantities in shaping the value of trade. The Australian government based its budget and economic forecast on iron ore prices at well below the prevailing prices and forward indications.  China apparently is stepping up its steel output and underpinning the amount of iron ore.  If the price remains firm, nominal growth will be stronger and tax revenues higher.

The Reserve Bank of Australia meets on August 4 amid a flare-up of the virus that will likely have a detrimental impact on the economy.  The RBA is reluctant to put its target rate below zero, as several European countries and Japan have done.  Still, there probably is scope cut the cash rate to 10 bp from 25.  It currently targets the three-year yield at the same level, and a cut here too is possible.  Economists generally do not expect a cut, but the market seems to be so inclined, judging from futures prices.

The Bank of England’s Monetary Policy Committee meets on August 6. The Bank of England is expected to stand pat for a little longer.  Officials have purposely not ruled out negative key rates, though until now, the only countries that have done so have savings that exceed investment (which is a current account surplus).   While all countries face a high degree of economic uncertainty, the UK is doubly cursed with the pandemic and the economic consequence plus the trade negotiations with the EU, which are not going particularly well.  This uncertainty, as well as the fact that it boosted Gilt purchases by GBP100 bln at its last meeting, favors a standpat decision now, but a clear signal that it is prepared to do more.

Four emerging markets central banks meet next week:  Thailand, Czech, Brazil, and India.  The former two are likely to remain steady, while the latter two are poised to extend their easing cycle.  Thailand is experiencing deflation (negative CPI), and its target rate is at 50 bp. The baht was the only Asian currency next to Indonesian rupiah that fell against the dollar in July (~0.75% and 2.2%, respectively).  With inflation running north of 3% in June and the key repo rate at 50 bp, and some preliminary signs that a recovery is taking hold, the Czech central bank is also likely to await further developments.  The krona rose nearly 6.5% in July, putting it up about 1.8% for the year against the dollar, dragged up by the rising euro (~4.8% in July after being essentially flat in the H1 20).

India has been hard hit, and it is not showing much sign of recovery.  Even though inflation had risen around 6% in June from a year ago, the Reserve Bank of India is likely to cut the key rates (repo and reverse repo) by 25 bp to 3.75% and 3.10%, respectively.  On the back of the weak US dollar, some foreign interest in Indian equities (~$1.3 bln flow, a little more than half of the outflow in H1), the rupee gained almost 1% against the US dollar in July.  

Brazil’s central bank has cut the Selic rate in half to 2.25% this year.  Official comments suggest the scope to cut interest rates is limited.  There probably is room for another 25 bp cut, but with the tepid recovery and inflation below the lower end of the 2.5% to 5.5% inflation target, the central bank may feel under more pressure.  It was officially empowered (temporarily) to buy public and private sector bonds.  The Brazilian real rose a little more than 4.7% against the dollar in July, which still leaves it down just less than 22% for the year.


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