Morning Commentary: Finding the Signal in the Noise

Foreign Exchange - Morning Commentary
Finding the Signal in the Noise
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
On the surface, the labor market in the U.S. appears to have taken a bigger COVID-19 hit than other major economies. There were mass layoffs in the U.S., with the unemployment rate spiking to 14.7%. Even after five months of reopening, the unemployment rate is more than double what it was at the pre-crisis low. In contrast, the unemployment rates in the euro area, Japan and the U.K. have stayed much lower.

Part of the discrepancy is due to accounting. In the euro area, Japan and the U.K., workers furloughed are counted as employed, whereas in the U.S., furloughed workers are counted as unemployed. Because the COVID-19 crisis is seen as a temporary shock, many workers are described as furloughed.

There is also the legal aspect. The U.S. and the U.K. typically allow more flexibility to lay off workers than the euro area and Japan. In addition to existing strong jobs protections, Japan and some euro-area countries also added supplemental labor market support. As for the U.K., while the labor laws are generally less restrictive, the government initiated a Job Retention Scheme. While it should be noted that a surge in U.K. unemployment is expected when the U.K.’s job scheme ends this month, the broader message is that the U.K., euro area and Japan have absorbed much of their labor market shocks through a reduction in work hours instead of jobs.

Given this, it is important to realize that during “normal” times, flexible labor laws have worked well in the U.S. By making it easier to lay off workers, companies are more willing to hire or risk over-hiring in good times. So while the U.S.’s unemployment rate is more volatile than Europe’s rate, the U.S. rate is also significantly lower on average. But due to the unique nature of the COVID-19 crisis, the trade-off between upside and downside now skews toward jobs protection, and the policy response suggests that the policymakers understood this. A big reason that the U.S. unemployment rate didn’t spike as high as economists were forecasting is the Paycheck Protection Program (PPP). Nevertheless, the PPP was available only to small businesses, which could be why the U.S. unemployment spike was higher than other DM economies.

Ultimately, the differences in experiences across countries doesn’t change the fact that damage to all labor markets has been serious, and jobs remain very much dependent on government support. With disinflationary pressures present globally and nearly all central banks falling short of inflation and employment goals, the next policy step is more likely to be further easing rather than tightening, cementing all of us in a world of chronically low inflation and rates.
  • House Speaker Pelosi and Treasury Secretary Mnuchin held another round of stimulus talks yesterday with no progress reported. While the gap between the two sides is the narrowest it has ever been, with Democrats at $2.2 trillion and Republicans at $1.6 trillion, a deal remains unlikely. The two sides will meet again today.
  • Federal Reserve Chairman Jay Powell speaks later today and is expected to reiterate his view that the economy needs more fiscal stimulus.
  • European Central Bank (ECB) President Christine Lagarde admitted in an interview that the recovery looked “a little bit more shaky” as COVID-19 infections continue to rise in Europe. However, the risk of a “cliff effect” from any sudden stop to government support is the risk that worries ECB President Lagarde the most. Notably Madame Lagarde acknowledged that the ECB currently views other policy tools as more effective than a rate cut but added that the ECB does not see a rate cut as doing more harm than good. The ECB’s next meeting is Oct. 29, but it is likely to hold off unveiling new stimulus measures until its Dec. 10 meeting when new macro projections are released.
  • On Brexit, the EU has no plans to offer concessions to the U.K. before next week’s deadline, as it bets the U.K. will not make good on its threat to walk away from talks.
  • The Reserve Bank of Australia held its policy rate and its target yield for its three-year bond unchanged, but the tone of the statement was dovish. The bank confirmed that it would not increase its policy rate until progress is made toward full employment and until it is confident that inflation is sustainably in its target band. The bank’s statement also noted that the bank “continues to consider how additional monetary easing could support jobs as the economy opens up further.” This makes a rate cut from 0.25% to 0.10% in November a very likely scenario.  Additionally the Australian government unveiled its 2020 budget that brought forward tax cuts, extended employment schemes and added to the government’s infrastructure push.
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