Morning Commentary: Forecasting: More Art Than Science

Foreign Exchange - Morning Commentary
Forecasting: More Art Than Science
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
When it comes to economic forecasting, the process involves more art than it does science.  This holds especially true now with the portfolio of unusual shocks hitting the economy.  The big question now is whether to put more weight on the positive growth momentum or the negative growth shocks just over the horizon.  On balance, it seems most prudent to side with the argument for a slowdown due to the variables at play.  

After the sharp jump in economic activity post-shutdown, attention quickly turned to how quickly the recovery would slow down.  The argument for a slowdown stemmed from the easy part of the recovery being over, a continued virus presence that would constrain activity, fading fiscal stimulus and second wave concerns.   In hindsight, the recovery did not slow as much as expected, likely because the economy reopened quicker than health experts recommended and forecasters underestimated the lag effect of fiscal stimulus.  

This outperformance of expectations notwithstanding, we appear to be approaching the tipping point where negatives outweigh the positives.  COVID cases are rising and should continue to do so as activity moves indoors for the fall/winter.  The risk of a contested election has also risen and will likely be one of the most contentious elections in US history if one side doesn’t have a compelling margin when polls close.  Most importantly, further fiscal stimulus does not appear to be coming in the near future, which is a departure from early August when another fiscal package seemed likely before the election.  

Since then, we have moved into pre-election gridlock with the Supreme Court battle casting a shadow over stimulus talks.  Absent an election party sweep, this Washington DC gridlock could extend into next year.  As a result, forecasters have been unwinding their assumptions for further stimulus.  Keep in mind that the additional stimulus expected would have been the second largest in history in absolute terms and the third largest as a percentage of GDP.  Despite the delay or outright cancellation of further stimulus, market consensus for GDP growth is barely moving.  

Likely, this reflects the magnitude of uncertainties making it difficult to pin down a baseline view.  In essence, the original forecasts never fully accounted for massive new stimulus and the new revised view doesn’t fully factor out the possibility of further fiscal support.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Risk markets are selling off as markets have shifted into risk off following news that President Trump and the First Lady tested positive for COVID-19.  Beyond the near term knee jerk reaction, a market positive outcome is possible should this development consolidate Biden’s odds of winning and reduce the chances of a contested election.  The US dollar is only marginally higher suggesting that FX markets are pricing in a potential Biden victory and a Democratic sweep.  
  • US non-farm payrolls added fewer jobs than expected with the economy adding 661K jobs against expectations for an 859K print.  The unemployment rate fell to 7.9% as the labor force participation rate dropped to 61.4% from 61.9%.  
  • House Democrats passed their $2.2 trillion stimulus plan overnight with Speaker Pelosi noting that the vote doesn’t close the door on further negotiations.  Nevertheless, the chances of a compromise remain very slim. 
  • The GBP has received a boost on reports that PM Johnson and the EC President von der Leyen will meet this Saturday for direct talks.  This is seen as positive news as most of the progress has come through direct negotiations between high level officials and the hope that more political capital behind the talks improves the odds of substantial progress.
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