The Week Ahead: “W”-orrying vs. “V”-orrying Outlook
“W”-orrying vs. “V”-orrying Outlook
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Andrew Kositkun Foreign Exchange Head Trader
On a relative basis and within the developed markets, the US remains the biggest COVID-19 concern with a higher peak and a slower descent than seen in developed Europe. Further cases are reaccelerating in the US while stabilizing in Europe. Nevertheless, the US and other countries around the world are pressing ahead with re-opening as the massive economic burden of blanket shutdowns leaves little choice.
As economies re-open ahead of schedule, both in the US and globally, headline measures should continue to post impressive growth rates as the global economy pivots off of a very weak base. For this to be sustainable, economic re-openings must continue according to plan and consumers and businesses must be willing to reengage with the economy.
On the first point, the risk remains for reopening decisions to be reversed or paused should infection data get sufficiently worse. Should enough countries backtrack on re-opening, there could be a “W” shaped recovery. To this point, there appears to be little political appetite for renewed blanket lockdowns. So while infection data continues to worsen, the reopening process should continue as planned.
The second and more important point is the willingness for consumers and businesses to reengage. A recent study out of the University of Chicago concluded that 90% of the slowdown in consumer traffic was due to consumer choice and not legal restrictions. Similarly, some businesses (see Apple Stores) have gone to voluntarily business closures. Therefore, even if lockdown measures continue to ease, the voluntary distancing due to increases in virus infections will likely be a powerful economic headwind.
One positive development has been the drop in the global mortality rate despite the increase in daily cases. This global decline has predominantly been driven by Europe and North America. To an extent, this makes sense. In the early stages of the outbreak, testing was inadequate so a large number of less severe cases were not recorded. This resulted in an elevated death to cases ratio. A more perplexing question is the driver of relatively low mortality rates in the EM. It seems reasonable to assume that inadequate testing would result in a higher mortality rate as seen in the DM. Possibly the EM’s lower mortality rate is due to emerging markets having a relatively younger population and/or lessons learned on treatment of COVID-19 cases.
Either way, a continued downtrend in mortality rates is a massive positive for the economic outlook. To state the obvious, a lower risk of death is critical to boosting confidence enough for consumers and businesses to fully reengage.
Cross currents continue to categorize the FX markets. The bull case for the euro stems from the strong pandemic driven fiscal response with several key countries, including Germany, turning expansionary. While caution is advised in extrapolating the steps taken into a full blown fiscal union, the removal of some negative risk premium is warranted as positive progress has been made. Opposition still exists from the frugal four so the risk is for the final version to be a watered down derivative of the original proposal. Nevertheless, the signaling aspect of the EU’s collective step towards fiscal integration should put a floor underneath the euro. Conversely, rising infection rates around the world puts uncertainty around the prospects of reopening. Nevertheless, there is little political will for renewed blanket shutdowns, which means the reopening process should continue and support cyclical currencies.
The UK government has started to lay the groundwork for ending its Furlough Program as the UK is fully pushing ahead with re-opening. Additionally, Brexit negotiations are back in focus with face-to-face meetings scheduled. Flow data this past week has shown decent two way interest in sterling. In the near term, expect headlines around Brexit talks to drive the currency as a decision needs to be made on whether or not to request an extension.
The yen has traded in a narrow range since the middle of June, but looking ahead, the bias is skewing towards yen appreciation. Japan is facing a prolonged period of disinflation, if not outright deflation. Conversely, inflation expectations are rising in the US, making it likely that real rates will rise faster in Japan than the US and support yen appreciation. On a global level, expect safe haven currencies, such as the yen, to continue to be moved by overall market sentiment. With infection rates rising, the risk skews towards re-openings getting delayed and safe haven currencies being supported. As a final note, investment outflows have picked up again after a period muted activity.
Over a longer window, the CAD has strengthened on re-opening optimism. However, over the past week, the CAD was the G10’s second worst performing currency as concerns of rising virus infections build. Despite the CAD’s run of strength through the first half of June, we have been bearish on the CAD due to its unique vulnerabilities to the COVID-19 crisis. Expect USDCAD to remain range bound and markets to weigh the positives from policy support with the risks from rising infections.
The yuan has received support from a more-dovish-than-expected US response to China’s moves in Hong Kong. In particular, the markets were concerned about the viability of the Phase 1 deal. Multiple reassurances from both the US and China that the deal remains intact puts confidence behind the deal and reduces the risk of further tit for tat escalation. While skepticism is warranted that risks have fully receded over the medium term, especially as we move closer to the US election, expect continued stability for the CNY near term.
The expectation remains for the Aussie to remain true to its correlation with equity markets and overall market sentiment. Near term, the government’s JobKeeper program and global policy support should continue to provide a base for the Australian and global economies. This should mean that the AUD also remains supported. The picture is a bit different over the medium term. For a while, we have been expressing the view for AUD weakness over the medium term and rising infection numbers around the world supports this. Valuation also remains elevated and uncertainty around Australian-China tensions should continue to weigh on the economy.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Brexit Extension Deadline
Expectations for rates to remain unchanged at 0.0%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US ADP Jobs Report
Expectations for a 2.8 million increase in jobs
US ISM Manufacturing PMI
Expectations for a 49.3 print
US Non-farm Payroll Report
Expectations for a 3.0 million increase in jobs
US Initial Jobless Claims
Expectations for a 1.3 million print
Canadian GDP MoM
Expectations for a -11.5% decline
EZ CPI MoM
Expectations for a 0.3% increase
EZ Unemployment Rate
Expectations for a 0.4% increase to 7.7%
German CPI MoM
Expectations for a 0.3% rise
German Manufacturing PMI
Expectations for a 44.6 print
Asia/Japan, and New Zealand
Chinese Manufacturing and Non-manufacturing PMI
Expectations for a 50.5 and 53.7 print, respectively
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