Synchronization of the Business Cycle

The pandemic has served to synchronize business cycles.  In the first instance, it was a body blow to economies.  After the first shock, it was a question of containing the outbreaks, ensuring the financial markets and bank functions have normalized to facility the economic recovery.   It appears March and April were the worst and that subsequently, economic activity has gotten less bad and some early signs that an expansion may be taking hold.  It is early and uneven, but it is real. 

Even in the US, which on the whole, appears to have done an unreasonably poor job of containing the virus, data, including the first set of regional Fed manufacturing surveys, are being reported above the median economic forecasts.  This is evident in the data surprise models.  Ultra-high-frequency economic activity metrics, like railroad traffic, is trending higher on a week-over-week basis.  Indeed, manufacturing appears to be gaining momentum as auto plants re-opened.  In June, auto output soared by more than 100% month-over-month, additional gains are expected throughout the quarter.  Excluding autos, manufacturing output rose by nearly 4% in June.

More states are limiting, and in some cases, reversing the re-openings.  In terms of percentage of the population and economic activity, these states appear to account for a substantial fraction. After all, California, Texas, and Florida are among them. Nevertheless, day-to-day measures of consumer confidence have not been undermined, so far. It appears that what is happening is that the parts of the economy that are opening up are more than compensating for those experiencing new closures. Also, the issue is about the pace of the economic activity, not so much the direction.

The better than expected data have spurred economists to revise up Q2 GDP forecasts. The first estimate is due at the end of the month.  The Atlanta and St. Loius Fed GDP trackers see a contraction of around 33.5%-35.5%.  At 14.3%, the NY Fed’s tracker sees less than half the decline, and its models suggest a 13.2% expansion in Q3, up 3.1 percentage points in the past week. 

In a rather light week ahead in terms of economic data, the preliminary July PMIs stand out.  The US report is likely to underscore the rebounding manufacturing sector.  The manufacturing PMI finished H1 at 49.8 and likely moved back into expansion mode in July.  It stood at 50.4 last July.  The lagging service sector means that that composite likely remained below 50.

The US composite was 47.9 in June, and the eurozone was at 48.5. Recent sentiment surveys showed a clear preference of asset managers to be long the euro and overweight European equities.  Flow models suggest the euro is the most bought currency. It partly seems predicated on the idea that Europe will outperform the US. 

Unlike the US, France, Italy, and the UK, the German service sector is leading in recovery rather than manufacturing.  Germany service PMI could reach 50 in July (from 47.3), while the manufacturing sector may struggle is projected to reach 47 (from 45.2).  France is somewhat less reliant on goods exports than Germany, and its economic recovery has been more pronounced.  In June, the PMI’s were already above 50.  The manufacturing PMI was at 52.3, and the service PMI was at 50.7.  The result was a 51.7 composite, which finished 2019 at 52.0. 

It is not just that the German recovery is trailing France, but the rebound might be faster in the periphery, as well.  June was the second month that Italy’s composite was above Germany’s (47.6 vs. 47.0, respectively).   They both bottomed in April (17.4 and 10.9, respectively).  Spain’s composite moved above Germany’s in June as well.  It rose from 29.2 in May to 49.7 in June.    The UK’s June manufacturing PMI edged above 50, while 47.1 service PMI kept the composite below 50 (47.7).

Japan remains a laggard, though it is for different reasons than Germany.  Japan’s exports as a percentage of GDP are closer to the US in the mid-teens than Germany and others in Northern Europe than can be 2-3x larger.  Japan will start the week with its June trade report.  Through May, it recorded a JPY1.97 trillion trade deficit.  It was about JPY1.49 trillion in the same year-ago period.  Japan’s current account surplus is driven by income from past investments.  This is interest and dividends on foreign portfolio investment.  It is royalties, licensing fees, and profits from overseas.

Just as there does not appear to be a good time to build the tallest building in the world, as it seems to often mark the high in commercial real estate cycle, so too is that simply no good time to hike the sales tax in Japan. The economy contracted in the last three months of 2019 and appeared headed for a contraction in Q1 2020 even before Covid-19 infected the first person in Japan.  It does not report Q2 GDP until mid-August.  Early forecasts suggest it contracted almost 23% at an annualized rate.  The economy appears to have ended the quarter with little momentum.  The manufacturing PMI was at 40.1, and the service PMI stood at 45.0.  This produced a composite of 40.8, the poorest in the G7.

Three G7 central banks met last week without a change in stance (Bank of Canada, Bank of Japan, and the ECB).  Indonesia’s 25 bp rate cut on July 16 after the Bank of Korea remained steady, signals the shift in the focus back to emerging market central banks.  Four meet next week ahead of  FOMC at the end of July (28th-29th).  

Russia and South Africa are likely to cut rates. Russia reduced rates by 225 bp this year, but with CPI around 3%, there is scope for additional cuts in the key rate that stands at 4.5%.  A 25 bp point cut after the 100 bp move last month is a safe bet, though there seems to be a higher chance of 50 bp than standing pat.  South Africa has scope to cut rates further, too.  The key repo rate is at 3.75% after finishing last year at 6.5%.  Headline inflation is around 2%, while the core stands at 3.1%.  The rand is the strongest currency in the world this quarter that is half over with a 4.5% gain, leaving it down around 15.7% for the year.  

Hungary and Turkey have sometimes pursued unorthodox policies, but cuts in the week ahead do not appear particularly likely.  Hungary surprised investors last month with a 15 bp cut in the base rate to 75 bp.  The overnight deposit rate was left unchanged at minus 5 bp and is the more important rate.  Turkey’s aggressive rate cuts, coupled with rising price pressures, leave it little room to maneuver.  The one-week repo was halved last year to 12%.  The central bank cut rates by another 375 bp in the through May before standing pat in June at 8.25%.  Inflation has risen to 12.6% in June, the highest since last August.  

Turkey appears to have done a remarkable job in containing the virus, and this may help facilitate are stronger recovery.  The lira has stabilized, and volatility has fallen.  The dollar has been mostly confined to a TRY6.83-TRY6.89 trading range for the past month and is virtually flat. The three-month implied volatility is near 12.5%, around half of the April peak.  

China sets its Loan Prime Rate on the 20th of each month.  It is based on submissions by banks.  While it is a benchmark and is portrayed as market-driven, the PBOC’s open-market operations, and especially the rate of the medium-term lending facility, seems to really drive it.  The steady rate last week strongly suggests that the one-year loan prime rate will also be steady (3.85%).  The stock market, which had soared in the first part of July, came back to earth last week with a nearly 7% loss by the Shanghai Composite, almost halving this month’s gain.   Chinese officials appear to have tried to temper or walk back their apparent encouragement of the buying surge.  The pullback in equities helped take the pressure of bonds, where the 10-year yield has climbed by nearly 60 bp since the end of April and peaked a little shy of 3.10% on July 9.  It finished last week near 2.95%.  

The sell-off in the Hang Seng (~-5%) last week, to new lows for the month, reduced demand for the Hong Kong dollar that had been threatening to push it below its band. The Hong Kong Monetary Authority repeatedly bought dollars in recent weeks.  It is tight ranges and small moves, but the HKD7.8548 level seen on July 16 was the strongest level for the US dollar since the end of May.  It appears that mainlanders buying IPOs and other companies via the Shanghai and Shenzhen links were a driving force and on the other side of the HKMA.  It helps explain one of the reasons why the Hong Kong market has been so resilient in the face of its changing fortunes.  

Officials at the Swiss National Bank, who also have resisted market forces by intervention in the foreign exchange market, must also be feeling a little more comfortable. Without trying to reintroduce a formal floor for the euro (cap for the Swiss franc), it fought tirelessly in April to defend CHF1.05.  Officials got excited when late-May and early June the euro soared to CHF1.09.  However, pressure returned, and the SNB appears to have made a gallant effort to mount a forward defense, and the euro held CHF1.06.  Judging from the increase in domestic sight deposits, the SNB stepped up its intervention in the first part of July.  The new sight deposit report, covering the past week, is released on July 20.  If the sight deposits rose again, it would suggest more aggressive official tactics, in effect, pushing the franc lower in an offered market rather than defensively trying to cap it in a rising market.  

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