Morning Commentary: Sunny With A Chance of Rain

Foreign Exchange - Morning Commentary
Sunny With A Chance of Rain
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Data out this week, including business sentiment for major economies through PMI prints and the US jobs report, should confirm the dire straits in which the global economy remains.  However, it is expected that the economic releases will also show some recovery from the April lows and support the narrative that the worst may be over.  The gap between risk markets and the real economy remains sizeable and a high degree of uncertainty remains over the medium term, but the expectations remain for markets to remain supported in the near term.

Massive, if not unprecedented, policy support should continue to aid the divergence between weak underlying growth and equity strength around the world via the prospects for improved growth.  In Europe, the European Commission outlined a larger than expected rescue package that represents a possible game changing inflection point should the partial debt mutualization proposed lead to a deeper union.  To be clear, intense negotiations lie ahead with the negative reception from some European countries capping further euro gains heading into the EU Summit in mid-June, but the mere proposal of larger-than--expected fiscal transfers should provide support. 

In Asia, governments have also stepped up.  Japanese Prime Minister Abe’s administration launched its second supplementary budget and the Singaporean government delivered its fourth fiscal package.    

Three key central banks meet this week and should continue the trend for a swift expansion of central bank balance sheets.  The ECB should expand the size of its PEPP purchases and add forward guidance to its PEPP reinvestment policy.  In Canada, the BoC Governor Macklem takes over this week.  Gov. Macklem appears to be more willing to use unconventional monetary policy tools than the previous Governor but there likely won’t be a major change this week as it is his first meeting.  Finally, in Australia, the RBA is expected to keep its rate unchanged, but the tone of the meeting should provide support to market sentiment.  

But this sanguine near term view does come with risks.  Broadly speaking, the rally in global equities reflects policy support rather than the real economy, which remains very weak.  More specifically, US-China tensions remain and second wave COVID risks loom.  While infection rates have improved in previously hard hit DM countries, some EM countries are experiencing a surge in cases.  

In the near term, optimism around risk and hopes for EU fiscal measures could support a further recovery in risk assets but caution would be advised against extrapolating out recent price action as an all clear signal.   
  • US-China tensions remain in the headlines, but so far market reaction has been measured.  Last week, risk markets actually rallied after President Trump’s press conference on China as it lacked actions that would meaningfully impact the economy.  However, tensions have taken a significant step up with Chinese policy makers instructing major state run agricultural companies to stop some purchases of American agricultural goods.  This puts the Phase One deal at risk as halting the purchase of agricultural goods is a direct hit at the states President Trump needs to win for re-election.  The dynamic of Trump having to win re-election but Xi not needing to has been a long running theme and the extent to which Xi believes this gives him a stronger hand likely plays a major role in determining how things play out. 
  • OPEC+ is considering extending output cuts by one to three months as the supply of oil nears one billion barrels with sources saying the group may bring forward its next meeting. 
  • Brexit talks resume this week and both sides remain far apart.  Brinksmanship that has, for years, categorized Brexit talks continue.  There is less than a month to go before the deadline to request an extension.  Thus far, the UK has been steadfast in its opposition for an extension, but the coronavirus pandemic does provide political cover to do so.     
  • China’s PMI data delivered a positive surprise, printing 50.7 against expectations for a 49.6 print. Last night’s print was the highest since January and signals expansion despite weak external demand. 
  • Eurozone PMI came in mixed.  At the Eurozone level, manufacturing PMI slightly missed at 39.4 against expectations for a 39.5 print.  On a country level, Italy, Spain and France beat expectations with Germany slightly missing to the downside.
  • US ISM manufacturing PMI came in at 43.1 against expectations for a 43.8 print.  US Markit manufacturing PMI also came in below expectations at 39.8 versus consensus for a 40.0 print.  Construction spending also missed as it fell -7.0%. 
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