Morning Commentary: The Cost of Closure

Foreign Exchange - Morning Commentary
The Cost of Closure
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The key data release this week will be this Friday’s US non-farm payroll report.  Over the past six weeks, the US economy has seen a record number of job losses with over 30 million Americans filling jobless claims.  Looking specifically at the month of April, market consensus is for the government’s jobs report to show a loss of ~21 million jobs and for the unemployment rate to rise to ~16.0%.  Certainly, there is uncertainty as to where these numbers ultimately come in, but it is a foregone conclusion that the official number will be bad.  

The US economy has experienced an unprecedented shock to both supply and demand.  While the supply side of the equation should get some relief once the economy reopens, at some point this year, the demand side should still remain a constraint.  Income and confidence will be severely damaged which leads to companies having little pricing power and strongly supports the argument for disinflation or a fall in prices.  

It’s not a secret that the US is a services-driven economy and that reflects in inflation measures.  Services has a 75% weight, compared to 25% for goods, when calculating both core inflation measures.  As a result, swings in core services will have a large impact on broader measures of inflation.  This is of concern because rents, which is one of the biggest drivers of inflation (40% weight) is tied to the labor markets and the labor markets have clearly been hit hard.    

Last week brought us the US’s Q1 GDP report that printed a horrible number.  Unfortunately, as bad as Q1 was, Q2 is highly likely to be even worse as virus related lockdowns didn’t begin in earnest until the back half of March and have continued through April.  This makes the US economy vulnerable to a record breaking collapse in QoQ real GDP with estimates of a 30% decline not uncommon.   

But that is a bridge to cross at a later date.  Near term, expect the markets to remain focused on virus developments and April’s jobs report on May 8.  

  • Virus news overnight remained positive with Italy reporting the fewest deaths since the lockdown began and Germany’s new infection rate hitting 5-week lows.  In the US, the infection rate moved down to 2.3% from last week’s daily average of 2.7%.  
  • President Trump continues to push to reopen the economy and push for further assistance for the jobless.  However, Trump has indicated that a payroll tax will be needed for him to sign off on any additional aid.       
  • US-China tensions continued to remain tense over the weekend.  President Trump promised a conclusive report on the origins of the virus after Secretary of State Pompeo stated there was “enormous” evidence that the virus began in a Wuhan lab.  Part of the US’s rhetoric included the threat to withdraw from the Phase One trade deal.  Uncertainty around the virus’s impact of growth already has investors on edge, and the possibility for the reemergence of the US-China trade war only adds to this.  
  • The Chinese yuan initially spiked higher in the overnight session but has since recovered all of its losses and is slightly stronger on the session. Over the medium term, it is possible that US-China relations are put under the microscope as the US elections approach.  However, near term, there appears to be support.  Friday’s move was exacerbated by thin liquidity with China out on holiday.  Liquidity should return when China comes back on Wednesday. Moreover, the overnight session saw decent CNY demand after the initial pop.  
  • Oil prices remain under pressure as demand and storage concerns continue and the possibility of renewed US-China tensions weigh on sentiment.  Overnight, a Hong Kong oil ETF was not allowed to add to its oil futures holdings.  
  • Eurozone manufacturing PMIs came in at 33.4 vs. estimates for a 33.6 print.  European PMIs continue to reflect the ongoing economic contraction in the area.  The next ECB meeting is scheduled for June 4 but action before then is possible should data continue to worsen. 
  • Japanese PM Abe announced that he will extend the national state of emergency until May 31.  Japan remains out on its Golden Week holiday until this Thursday.  
  • The UK’s lockdown is set for a formal review this Thursday, the same day as BoE’s policy announcement.  
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