Morning Commentary: L U V

Foreign Exchange - Morning Commentary
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The highlight for the day has been Fed Chair Powell’s webinar for the Peterson Institute for International Economics.  In this webinar, Chair Powell expressed the view that the US economy is facing unprecedented downside risks.  As such, “additional fiscal support could be costly but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery.” 

These comments have pushed the USD down to its session lows with Fed funds futures showing a negative Fed funds rate by early 2021.  The view here is that the Fed will be hesitant to move to negative rates, making yield curve control the more likely next step should the Fed expand its unconventional policy toolkit.    

Powell’s comments reflect the high uncertainty that remains and explains why there is much disagreement around the shape of the recovery as economies re-open.  Some of the more commonly discussed shapes include a L, U, V, W or “swoosh” shaped rebounds. 

The reality is that the current cycle is so unique that it breaks the mold created by past events.  So instead of trying to find a past example to model what will happen, maybe it’s better to think of things in stages. 

The shutdown, which started in mid-March, is the first stage and was categorized by a steep drop in economic activity.  The good news is step one is over, the bad news is that it was painful. 

The second stage, in which we are currently, would be the transition where GDP bottoms.  This stage started in May and had weak consumer spending hitting the real economy.  Stimulus helped spur a rebound in consumer spending but business investment remains weak.  

The third and final stage would be the recovery.  This stage will be highly dependent on three factors: the path of the virus, stimulus support and residual damage to the economy. 

The path of the virus is the most important variable.  When economies reopen, there will be an uptick in infections.  The important factor will be the slope of this uptick as a steep slope could lead to stronger distancing guidelines.  The bar for a return to a blanket shelter in place order is probably high but the “two steps forward, one step back” nature of reopening likely means behavior remains cautious and the recovery is slow and rocky. 
  • Virus news remains mixed with Europe continuing to take steps to re-open its economy.  Conversely, Dr. Fauci kept a more cautious tone. 
  • US-China tensions continue to swirl.  Senate Republicans are proposing a bill that will allow sanctions on China if the country fails to “cooperate and provide full accounting of the events leading up to the outbreak.”  While the US economy’s fragile state argues against an escalation in tensions, proximity to the US election and rising anti-China sentiment among both Republicans and Democrats argues for escalation.
  • House Democrats are set to propose another round of stimulus without Senate Republican input.  This package of stimulus is expected to be ~$3 trillion with talks expected to be contentious. 
  • Brexit talks continue to struggle with both sides playing hardball.  Additionally, the BoE delivered dovish comments yesterday and it signaled that it stands ready to do more. 
  • The senior judge behind the German Constitutional Court’s (GCC) ruling has tried to downplay his ruling.  As stated in past commentaries, the bigger issue is that the ECB is governed by the European Court of Justice, not national courts.  Should the ECB ignore the GCC ruling, it risks domestic issues in Germany, but if the ECB responds, it opens all EU institutions to questions from national courts and threatens the European experiment itself. 
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