One of the overarching themes of the COVID crisis has been the rotating nature of the virus. In essence, there appears to be a feedback loop where people tend to become more complacent when virus numbers are low and more vigilant when virus numbers are high. This leads to a phenomenon where the virus does not disappear as much as it just rotates around the world.
Recently, cases have started to fall in the US and parts of the emerging markets while they are picking up in Europe. To be clear, daily confirmed case numbers in Europe are still roughly one fourth of those in the US, but the gap is narrowing.
Looking backwards, we see that Europe has done a better job controlling the virus but has been less aggressive with its initial macro policy response. As a comparison, Europe’s fiscal stimulus package has been about 4% of GDP compared to 13% of GDP in the US. Granted some of this gap is narrowed by the stronger automatic stabilizers in Europe—during a recession, Europe’s more generous welfare benefits kick in automatically— but the difference in response is significant.
More recently, the US and Europe appear to be trading places. The US has started to see a downward trend in new virus cases with the infection curve turning up in Europe. The Southern parts of the US have begun adopting containment measures while Europe may have fallen victim to some complacency. August is a big vacation month in Europe and all of the movement appears to have reignited the virus, illustrating the feedback loop described above. For the first time in more than four months, the 7-day moving average of daily infections for the big 5 (Germany, the UK, France, Italy and Spain) has moved above 14,000.
In terms of policy, Europe has become more active with its $750 billion EU recovery fund while US stimulus talks have gotten lost in the mail. The standoff in Washington DC puts the US economy at risk of falling off a fiscal cliff for a prolonged period of time.
All of this nets out to both the US and Europe facing rising risks to their recovery. Neither side has been able to put together a consistent and comprehensive policy response which stands in contrast to a virus risk that is unrelenting.
Better US economic data, a sell-off in equities and ECB Governing Council members voicing concerns about the euro’s appreciation have helped the USD reverse its downward slide. Over the past couple of weeks, EURUSD has been dominated by US specific factors (fiscal cliff, election, Fed’s policy review) but that focus should shift back to Europe this week with the ECB meeting and the already discounted USD. Economic activity and mobility data in Europe have started to show signs of slowing, but aggressive policy support should help relieve some worries around Europe’s recovery momentum. Regarding policy support, the ECB is meeting on September 10 and is widely expected to keep rates unchanged, putting market focus on other parts of the bank’s policy framework. Expect further consolidation.
The view remains that recent GBPUSD strength is more attributed to USD weakness than GBP strength. On the GBP side, politics and data remain important with the following issues of particular importance: Brexit (deal or no deal), unemployment (what happens as the furlough scheme rolls off), and lockdowns (return to work/school and potential second wave). The next round of Brexit talks will be September 7-11 but there aren’t any indications of a near term breakthrough. More immediately, the UK government will have to make decisions on whether to extend some emergency support programs such as the Coronavirus Job Retention Scheme. A discounted USD suggests consolidation on that side of the pair, leaving near term Brexit and fiscal cliff concerns to take a great share of market attention.
Better US data and a reversal of the knee jerk reaction to PM Abe’s resignation announcement has helped USDJPY turn higher on the week. In the race to succeed PM Abe, Chief Cabinet Secretary Suga continues to build support for his candidacy. As Abe’s right-hand man, Suga most represents a continuation of Abe’s policies. Given this, whoever is the next PM will be focused on party consolidation and the next election. This gives little incentive to change policy with the Japanese economy weak and the next election imminent. USDJPY should remain in the range it has been over the past couple months with the USD side being the driver most likely to move USDJPY out of its range.
Greater market sentiment should continue to drive USDCAD. The BoC kicked off its Policy Framework Review for 2021 last week so markets will be looking for clues over the coming months. Frameworks being considered include: average inflation targeting, price-level targeting, an employment-inflation dual mandate and nominal GDP growth and level targeting. As with the Fed, should the BoC allow inflation to overshoot, it would signal accommodative monetary policy for longer. The BoC meets on the 9th of September but not much is expected. However, Trudeau’s budget towards the end of the month could provide some fiscal clues. USDCAD likely continues to range trade.
Headlines around US-China tension continue to come out, but ultimately, the markets are viewing the recent actions/rhetoric from both sides as largely symbolic. A strong balance of payment position and the market consensus for USD weakness form the base for a stronger CNY. Capital inflows, especially on the bond side, have been strong and are expected to be persistent as the global search for yield continues. Longer term, geopolitics remain a concern especially as we get closer to the US election, but for now, expect the yuan to be supported.
Q2 GDP officially put Australia in its first recession in nearly 30 years. On monetary policy, the RBA kept its cash rate and 3-year yield target unchanged this past week. The bank also noted that the virus outbreak and related lockdown are "having a major effect on the Victorian economy." The bank confirmed that it will not increase the cash rate or the yield target until progress is made toward full employment and it is confident that inflation is sustainably within the 2-3% target band. View remains unchanged. USD weakness should support AUDUSD but domestic headwinds and the AUD’s correlation to equities, that have turn shaky, should limit gains.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.25%
Expectations for rates to remain unchanged at -0.50%
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