Morning Commentary: Inverse Exceptionalism

Foreign Exchange - Morning Commentary
Inverse Exceptionalism
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
A key market focus this week will be the US’s Phase 4 stimulus plan.  The base case remains for a deal to ultimately get done as it is a political necessity for both sides with the expiry of some CARES 1.0 programs and the election approaching. 

Yet, last week’s negotiating difficulties illustrates challenges faced in getting a deal across the finish line.  Unfortunately, the differences extend beyond simply the size of the package—Republicans are targeting ~$1 trillion and Democrats are targeting ~$3.5 trillion.  The path of a compromise would be much more straightforward if it was just an issue of size.    

Instead, the fundamental issues lie in the nature of the proposals as they fall far apart on the traditional left/right political ideology divide during an election year.  Adding another wrinkle to the process is the disagreement among Republicans that is somewhat similar to the failed attempt to repeal Obamacare in 2019. 

This means markets will be forced to contend with the possibility that the US could fall off a fiscal cliff.  Case in point, the enhanced $600/week federal unemployment benefit and moratorium on evictions have expired.  For scope, the Federal Pandemic Unemployment Compensation (FPUC) program, which provides the additional $600/week unemployment benefit, has supported around 25 million workers or 15% of the labor force.  After accounting for income and aggregate demand multiplier effects, the FPUC program is shielding ~5% of GDP.  

The longer that Washington remains gridlocked, the more attention this self-inflected fiscal drag should draw to the building narrative of US inverse exceptionalism and add momentum to the recent move lower in the USD.  Even if you assume this fiscal trip up is only temporary, it still raises the possibility that the US economy could underperform for a material period of time.  This concern is enhanced when compared to the EU’s recent ability to cross political barriers to deliver needed fiscal stimulus, negative US performance in managing infections amid the reopening relative to DM peers, and the ongoing optimistic market view for the global economic recovery. 
  • This will be a big week for US data with updated information on personal income, Q2 GDP, the FOMC decision and earnings from Apple, Amazon, Alphabet, Facebook, Chevron and Exxon among others.  
  • Risk sentiment is modestly higher despite increasing concerns on rising US-China tensions and virus infection numbers.  Regarding the virus, the UK has imposed a quarantine on travelers from Spain with numbers continuing to rise in China, Hong Kong and India.  India has the fastest growing epidemic with cases increasing 20% to 1.4 million over the past week. In the US, the pace of infections has slowed and daily deaths has dropped below 1,000 for the first time in 5 days.   
  • The USD continues to weaken, hitting its lowest levels since the middle of 2018.  Rising US-China tensions, a reduction in European risks, rising US infection numbers and an impending US election have kept the USD trading with a bearish bias.  There are also signs that market participants may be rebalancing into other G10 currencies.  Notably, a breakdown of the USD weakness since mid-May shows that USD weakness is not broad based but rather focused between a stronger EUR complex (EUR + Scandies) and commodity currency strength.
  • Republican Senators are expected to unveil their $1 trillion stimulus proposal today which is expected to include a formula-based approach to extending the weekly jobless benefits and a $1,200 stimulus check.  Regardless of what ultimately makes it into the Republican proposal, expect a drawn out negotiating period between the two parties as the August recess rapidly approaches. 
  • In Europe, Germany’s IFO survey came in better than expected with the headline number, and especially the expectations component, beating while the current assessment came in slightly below expectations.  Overall, this report adds to the narrative that the worst is behind Germany.  Regarding Brexit, informal talks kick off today but not much is expected.
  • China took over the US consulate in Chengdu overnight and condemned the US’s “forced entry” into China’s consulate in Houston on Friday.        
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