July Monthly

Many major and
emerging central banks took action in June, but outside of possible technical
adjustments will continue with the current supportive stance in July.  The policy focus will
shift back to fiscal initiatives.  The highlights
will be the EU Summit on July 12, which is considering the EC’s 750 bln euro
package of grants and loans, and the US decision regarding the $600 a week
extra unemployment insurance (expiring at the end of July) and another large budget
bill ostensibly for state and local governments and infrastructure.

In the second half of June, more monetary support was provided,
though it took different forms and was not coordinated.  The Federal Reserve’s Main Street facility
was launched after being announced in late March.  The Fed’s corporate
bond purchase program began including individual issues rather than just ETFs,
which had been the case previously, and it will also buy bonds in the primary market. 

The Bank of Japan expanded interest-free loans to
corporations to JPY110 trillion from JPY75 trillion.  The ECB made net new
three-year loans of nearly 550 bln euro (at minus 100 bp), or a
10% increase in its balance sheet (~5.63 trillion euros as of June 12). 
The Bank of England boosted its bond-buying program by GBP100 bln. 

The People’s Bank of China cut its reverse repo rate by 20
bp and officials signaled further easing of monetary policy would be
delivered.  It also announced a 25 bp cut in the re-discount rate to 2%, which is seen helping small and medium businesses.  Other central banks, including Brazil (-75 bp to 2.25%),
Russia (-100 bp to 4.50%), Indonesia (-25 bp to 4.25%), the Philippines (-50 bp to 2.25%) Mexico (-50 bp to 5.0%), and Colombia (-25 bp to 2.50%).   

It appears that most of the major economies are past the
worst of the direct of economic impact. 
Going forward, nation-wide lockdowns may not be necessary, though localized
action could have broader knock-effects. 
As the second quarter wound down, several countries in Europe and Asia
have seen an increase in new cases.  The US is seeing a record number of cases, and a few re-opening exercises have been reversed, and others halted, while Mexico may be seeing early signs that the curve is bending, Brazil is
still in the throes of the worst of the epidemic.

The world’s two largest economies will report Q2 GDP in
July. China’s report is due in the
middle of the month.  Outside of
February, China’s composite PMI has been above the boom/bust 50-level. China’s economy contracted by nearly 10% in
the first quarter, and small but positive growth cannot be ruled out in Q2, though some economists are more pessimistic. The US economy contracted by 5% at an
annualized pace in Q1, and output may have fallen by 35%-45% in Q2.  It reports the first estimate at the end of the

The third quarter is widely expected to show strong
improvement over Q2 and there is good reason to suspect it was a historically
short but deep contraction.  The critical
issue going forward is about the pace of the recovery, which itself depends on
no small extent on the evolution of the virus. 
If new flare-ups cannot be totally avoided, as was seen in Beijing that
had a surge in cases after reporting no new cases for more than fifty days, then
the challenge is the speed and effectiveness of containment. 

However, after the third quarter, visibility is limited. Without a vaccine or specific
treatment, the recovery will likely be gradual and uneven.  The signs of green shoots may also temper the
will to maintain the extent of the stimulus. There may be two last hurrahs in July. 
A consensus may be reached for the EU Recovery Fund at the summit. 

protracted negotiations underscore that these are not emergency funds that will
be disbursed and spent immediately.  It
is a small part of the fiscal support many countries will need.  The subscript may be where the real political
importance lies.  A common bond that is
not an intergovernmental agreement, but something larger, some have suggested
is the “Hamiltonian moment” for Europe.  It
could be scaffolding for a greater fiscal union, but we are reluctant to
project emergency measures into the future.  Those fights still lie ahead.

In fact, in the current circumstances, a common bond itself is not so controversial.  By focusing on the potential significance of a common bond, the advocates have not confronted the main objection of the “frugal four” (Sweden, Denmark, Netherlands, and Austria).  Their complaint is how the proceeds of the bond will be used.  The German and French proposal is heavily weighted toward grants.  This does not sit well with taxpayers in the North.  

The US may approve another stimulus package in July  Previously,
the Congressional Budget Office projected a budget deficit of around 18% of
GDP.   If it weren’t for the elections in November, this
package might not have been considered. At the same time, most countries have neither
the political will nor financial capacity to provide as much stimulus.  After the Great Financial Crisis, the
divergence helped underpin the dollar.   This time a different dynamic appears to be at
work. The liquidity the central banks are providing, and the spending of
governments are encouraging the pursuit of risk-assets. And the dollar is the

At the same time, between loan guarantees and the fiscal
stimulus, German efforts are unlikely to be matched elsewhere in Europe.  Even with a generous package of loans and
grants, the EU’s Recovery Fund is not going to dampen that new divergence in
Europe could very well shape the next European crisis. 

EC President von der Leyen and UK Prime Minister Johnson
appear to have reinvigorated the trade talks, which will be accelerated in the
coming weeks. The UK indicated that
regardless of the outcome, it will relax the control that applies to trade with the EU for the first half of next year, seemingly making a virtue out of necessity.   If the Irish border was the critical element in the withdrawal bill, the crux of trade dispute might be over the future alignment of environmental and labor protections, and state aid.  Checks of plants and products of animal origins will also be particularly challenging for the UK.  Its ports lack the facilities and often the space to carry out such checks.  Some estimates suggest the UK may need to
hire as many as 50k more customs agents. 

Meanwhile, Japan has indicated that a trade agreement needs
to also be completed by the end of July to give it time to be debated and
approved by the Diet.  To achieve
this, the EU-Japan trade agreement that took effect in 2019 will likely simply be duplicated
to include the UK. The UK was pushing for a further reduction (or elimination) of Japanese
tariffs on goods and agriculture, like beef and cheese.   

Dollar:  The
dollar fell against all the major currencies in May but sterling and the yen  It fell further in June, though sterling was the exception, slipping about 0.2%  The JP Morgan Emerging Market
Currency Index fell 1% in June after rising 3.4% in May, which was the only month in H1 20 that it did not decline.  With the
funding markets functioning normally, the use of the Fed’s swap facility diminished, and the dollar was used again to fund the purchase of other higher-risk assets. Speculators, judging from the positioning in
the futures market, have amassed a significant long euro position. Outside of the yen, the non-commercials in the futures market were net short most of the other currency futures.  In the weeks ahead, negative surprises will
likely be more dollar supportive than unexpected positive news. 

Euro:  The ECB has aggressively moved to ensure that its ultra-accommodative monetary stance transmitted through the region.  In June, it increased the size of its Pandemic Emergency Purchase Plan by 600 bln euros and extended the program until at least mid-2021. It also made net new loans of about 550 bln euros for three-years at minus 100 bp.  The ECB’s balance sheet increased by roughly 11.5% in June, more than the previous two months put together.  What market participants call carry trades is the implementation of the ECB’s transmission mechanism.  The ECB buys bonds and provides incentives for investors to buy peripheral bonds, thus narrowing spreads. The next step is the European Recovery Plan, and there is cautious optimism that a compromise can be struck.  Europe appears to be doing a better job than the US in containing the virus.  Trade tensions with the US over digital tax, the Nord Stream II pipeline, and the threat of US auto tariffs, are simmering just below the surface.  Merkel assumes the rotating presidency of the EU in H2 20 and certainly has her work cut out. 

(end of March
indicative prices, previous in parentheses)

Spot: $1.1235  

Bloomberg One-month Forecast $1.1225 

forward  $1.1245 
($1.1110)    One-month
implied vol  7.1%  

Yen:   The dollar rose to almost JPY110 in early June, its highest level since late March, but quick retreated and tested the lower end of the range near JPY106 as the month drew to a close. The exchange rate’s co-movement with the risk appetites has weakened from the first part of the year.  The rolling 60-day correlation is around 0.15, after peaking above 0.80 in February and holding above  0.55 throughout Q1.  It was just below 0.50 at the start of June.  Other forces moved to the fore in June, and some observers emphasized the large corporate divesture (Softbank sales of T-Mobile, ~$20 bln).  The government and the central bank are cautiously optimistic that a recovery may be at hand.   The Bank of Japan forecasts a 4% contraction this year, which appears to be on the optimistic side of forecasts.  Soft (surveys) and hard data (industrial production) has disappointed.  Judging from the BOJ’s bond purchase plans in July, it will not object to further steepening of the yield curve.  The nearly five basis point increase in the 10-year benchmark yield was the most within the G7 in the second quarter. Japan’s 30-year yield a little below 60 bp. By comparison, the UK’s 30-year Gilt is a few basis points higher, while the German Bund yield is minus two basis points.  

Spot: JPY107.95 (JPY107.85) 

Bloomberg One-month Forecast JPY107.65  

forward JPY107.90  
(JPY107.80)    One-month
implied vol  5.8% 

Sterling: Sterling’s flat performance in June after the poor showing in May (-~2.0%) reflects the poor news stream from the UK.   Even when some data, like the preliminary June PMI was stronger than expected, sterling struggled to sustain even modest upticks.  The low for June (~$1.2250) was set late in the month.  The euro set a three-month high against sterling (~GBP0.9175) at the end of June, as well.  We look for a better showing from sterling in July, which is a critical month for the UK.  The country will be re-opening more quickly, and the risk of new flare-ups, as seen elsewhere, is a concern.  Trade talks with the EU are to accelerate, and the next several weeks will reveal if progress has been made.  The UK’s own customs facilities and personnel need to be expanded.  Japan is insisting that its trade agreement with the UK needs to be completed by the end of July to give the Diet sufficient time to debate and vote on it.  It may be little more than extending the agreement between the EU and Japan that took effect last year.  

Spot: $1.2400  ($1.2345)   

Bloomberg One-month Forecast $1.2415 

forward $1.2400 
($1.2345)   One-month implied vol 9.0% (8.9%)


 The US dollar fell out of the CAD1.3850-CAD1.4200 trading range of April and the first half of May and continued to fall in the first part of June, ultimately reaching nearly CAD1.33.   The greenback entered a consolidative phase in the second half of June, but there may be scope back into the previous range.  June will be remembered for the beginning of Macklem’s seven-year term as Governor of the Bank of Canada.  It will also be remembered for when Fitch became the first major rating agency to take away its AAA standing, citing rising deficit and debt levels in response to the pandemic (now, AA+ with stable outlook).  The housing sector appears to be leading the Canadian recovery. In Q2, Canada’s 10-year yield fell about 25 bp to lead the G7. The Bank of Canada meets on July 15. There is scope for technical adjustments as the markets have normalized.  

Spot: CAD1.3580  (CAD

Bloomberg One-month Forecast  CAD1.3585 

forward  CAD1.3575  (
CAD1.3800)    One-month
implied vol  7.0%  

The Australian dollar dropped 12.7% in Q1 and bounced 12.5% in Q2 (including a 3.5% gain in June).  The currency appreciation did not reflect the domestic economy, which has been hard hit by the virus.  The preliminary June composite PMI surged from 28.1 in May to 52.6.  In 2019, it averaged 50.5, and last June stood at 52.5.  The Aussie is one of the currency proxies for risk.  The rolling 60-day correlation between (percent change) in the Aussie and S&P 500 is near 0.7 and the highest eight years.  On a purely directional basis, the correlation is about 0.95.  The Reserve Bank of Australia meets on July 7.  No change in policy is expected, but it could raise the level of concern about the strength of the Aussie.  When exchange rates move in the opposite direction of monetary policy, it can dilute official effects.


Bloomberg One-Month Forecast $.0.6870  

forward  $0.6905
  ($0.6665)     One-month
implied vol 10.9%  

The dollar peaked around MXN25.7850 in early April, and two months later, it looks like it has bottomed near MXN21.45, a little above an important technical level. The peso is also treated as a currency proxy for risk, and it also serves as a proxy for emerging market currencies broadly.  The dollar recorded the highs for the month (~MXN23.23) on the last session.  The government’s response to the pandemic continues to appear relatively light. The central bank delivered its fifth rate cut of the year in June to bring the cash target to 5.0% from 7.25% at the end of 2019.  Banxico does not meet again until August when it could deliver a 25 or 50 bp rate cut depending on circumstances. While worker remittances have been stronger than expected, the trade position has deteriorated markedly.  In May, what was supposed to be a trade surplus was the second consecutive deficit over $3.5 bln.  Exports had fallen by almost 57% year-over-year, while imports were off 47%. 

Spot: MXN22.99 (MXN22.18)  

Median Bloomberg
One-Month Forecast  MXN22.77 

forward  MXN23.09 
(MXN22.28)     One-month
implied vol 18.8% 

Chinese Yuan:   The dollar peaked in late May near CNY7.1780 and returned to CNY7.05, the lower end of its two-month trading range, before the middle of June.  It was confined to CNY7.05-CNY7.10 trading range second half of the last month.  The 200-day moving average is around CNY7.0460, and the dollar has not been below CNY7.03 since mid-March.  Chinese officials have done a reasonably good job if their goal is for a stable yuan against the dollar.  It appreciated by about 0.25% in Q2 after falling almost 1.7% in Q1.  The stability of the yuan, while offering substantially higher rates than the US, may attract investment flows. Relations with the US continue to deteriorate.  China has boosted imports from the US recently, including meat, aircraft, and integrated circuits.  China has by-and-large, kept trade issues separate from other political issues. But, Beijing has warned on at least two occasions that if the US continues to challenge it on so many fronts, including on issues it regards as redlines, it will not be able to fulfill Phase One trade agreement.  China has only met about a fifth of the overall quantitative target through May.  

Spot: CNY7.0655

Bloomberg One-month Forecast  CNY7.0670 

forward CNY7.0795
  (CNY7.1350)    One-month implied
vol  4.2% 


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