Last week brought Q1 GDP data from many major economies. These ugly Q1 numbers provided a glimpse at the negative impact that social distancing measures have had on the economy. Unfortunately, as bad as Q1 GDP numbers have been in the US, Q2 will be much worse as China’s 35% annualized QoQ drop shows. Keep in mind that China’s shutdown measures hit Q1 GDP while the US’s should predominately hit Q2 GDP due to the difference in the timing of when lockdown measures were implemented.
Looking ahead at the next couple of weeks, a key driver for the markets should be whether or not countries will be able to successfully execute their exit plans. For the most part, most European countries and many US states have announced virus path-dependent exit plans so whether infection rates continue to fall or increase will be a key measure for the markets to watch.
Economic data clearly shows that the lockdown was bad for the economy, so reopening should be a positive. But even if the exit plans prove to be successful, the pace of recovery should be contained as long as the COVID-19 threat remains as this threat will keep many sectors from operating at full capacity. This, in turn, should also suppress investment and hiring. Moreover, some business may not be viable in this “new normal.” Combined, this suggests that an “L” or an elongated “U” shaped recovery is more likely than a “V” shaped recovery.
With regards to monetary policy, the Fed, BoJ and ECB all met this past week. Both the Fed and BoJ have moved to unlimited QE while the ECB has emphasized that it stands ready to increase stimulus if needed. But, it is important to remember that policy support, even if it’s beyond what the markets have been expecting, has been more about survival than recovery as lockdowns continue. To be clear, these policy measures are necessary, but without an end to the health crisis, policy measures alone cannot trigger a strong recovery.
To this point, there should be caution around the recent risk rally. Decisive moves from central banks, improving COVID infection statistics and progress towards treatments do justify a recovery in risky assets. However, a weak recovery with output well below pre-COVID levels is the most likely scenario. This supports the need for more macro policy support to avoid damage to the economy (bankruptcies/unemployment). Against this backdrop, it is hard to justify a bull market.
Yesterday’s ECB meeting went broadly as expected with the ECB stepping up its stimulus measures and communicating that it is ready to provide continued support. Month end flows pushed up EURUSD to around a 1-month high, but this is something I would fade as the view remains for USD strength and EUR weakness. The US has a stronger fiscal and monetary stimulus response as well as a stronger economy heading into 2020 than the Eurozone. Eventually, markets will have to shift its focus from stimulus to fundamentals and this should support the USD.
Cable moved higher on the week as the USD weakened, but bearish bias to the pound remains intact. While the UK government continues to move forward with plans to reopen sometime in May, headwinds to the economy persist. The UK has a current account deficit it needs to fund without an interest rate advantage as well as a backdrop of low growth. Of course, Brexit concerns remain with both sides far apart and time running out before an extension needs to be requested. Looking forward, keep an eye on the government’s plan to exit the lockdown and Brexit developments. The most recent round of talks wrapped up last week with little progress and will begin again in May.
Focus should remain on COVID-19 spread, easing of lockdowns and thinning liquidity due to the Japanese holiday. The BoJ met last week and left its rate and 10 year target unchanged. It did eliminate is QE limits but this is more a cosmetic change as the BoJ was buying under its limits anyways and YCC already allows unlimited purchases to maintain the target yield. News headlines suggest that Japan may extend its state of emergency another month. With outflows, that have previously muted yen strength, expected to drop, expect USDJPY to range trade.
The loonie has been fairly resilient despite the decline in oil, but the view here is that this isn’t sustainable. While oil prices have recovered, some of the outlook still remains uncertain. COVID-19 cases continue be a headwind and this should extend to supply chain disruptions and further pressure oil and global growth. In the absence of an interest rate advantage to draw foreign inflows to fund Canada’s BoP deficit, USDCAD should remain pressured. Tiff Macklem has been named the next BoC governor.
Economic data points continue to reflect a normalization of economic activity. However, the PMI report last week showed why China’s recovery will not be strong. Domestic activity has picked up, but external demand for Chinese goods remains weak with countries still on lockdown. The CNY weakened sharply at the end of last week as US-China tensions ramped up again. Part of this move was likely exacerbated by thin liquidity due to holidays in China. Look for USDCNY to fade these gains as liquidity normalizes. It’s always difficult to predict what the White House will do with China, but the view here is that no one wants a reescalation of trade tensions as the global economy continues to be rocked by COVID-19 headwinds. Neutral on the CNY.
The AUD continues to hold up well despite other commodity currencies in the G10 continuing to being hit and is the clear outperformer over the past month. Partly, this relates to iron ore prices holding up better than crude, but it also has to do with Australia’s relative performance. COVID-19 statistics have held up better in Australia relative to its peers, suggesting that the country could normalize sooner. Moreover, Australia’s stimulus response, as a percentage of GDP, also outperforms its peers. Given this, AUDUSD does appear to be stretched and rising tensions between the US and China are a negative.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.25%
Expectations for rates to remain unchanged at 0.10%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Services and Non-Manufacturing PMI
Expectations for a 27.0 and 37.2 print, respectively
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