For two consecutive months the US government jobs report delivered massive upside surprises. In total about a third of the jobs lost in March and April have been recovered and the unemployment rate continues to fall. Average hourly earnings did tick down but this is more due to low wage workers being re-hired and bringing down the average than a drop in wages.
Yet the overall labor market still remains challenged with economists struggling to forecast the path forward. Most high-frequency labor market indicators point to labor market weakness. Specifically continuing claims remain elevated and initial jobless claims remain very high at over 1.3 million this past week and over 1.4 million since the start of June.
Thus far the markets don’t seem to care about rising infections. Price action on risky assets seems to infer that policy support is unlimited and a vaccine is coming shortly. Add to this the focus on a lower mortality rate and you likely have explained away a lot of the market’s apathy.
But this view should be taken with caution. The virus appears to be less lethal because more susceptible people are thankfully avoiding infection but that doesn’t mean infection news should be ignored. The more prevalent the virus the more prevalent restrictions will be. This means virus penetration and not just lethality will have an effect on behavior.
When looking at the June jobs report it is also important to remember that the survey was taken the week of June 13th. Clearly a lot has changed since then with COVID-19 case having picked up markedly. Simply put, many more people are being infected in the current wave than the initial one. While the data suggests a higher concentration in the younger segment of the population (which contributes to the lower death rate) the median age is still increasing on the margin.
After accounting for the usual recognition lag, expect economic disengagement to be reflected in economic data. Reduced mobility data suggests this is already happening and increased pauses in re-openings cemented this narrative. Absent a breakthrough on an effective and widely available vaccine, the virus will be with us for an extended period of time. This supports a tilted “L” rather than a “V” shaped recovery. Given this, it has to be acknowledged that risk asset pricing doesn’t reflect this and in the absence of a catalyst for correction, this decoupling from the real economy can persist.
This past week brought a bit more drama to the US-EU relationship via further trade tensions. While these developments did garner some headlines, the overall outlook remains unchanged. The euro remains stuck between optimism around policy support and pessimism around rising virus counts. This upcoming week brings two key events, the ECB meeting and the EU Summit where the rescue package will be discussed. With regard to the ECB, the bank is widely expected to keep its policy rate unchanged. On the other hand, the EU Summit brings in much more headline risk. Positive news around the proposal and support from key countries such as Germany and France have given the euro support. Nevertheless, unanimous approval is needed and the Frugal Four among other countries still represent opposition. Most likely a deal will not be reached this month so expect euro price action to reflect the tone of progress or lack thereof on the rescue package.
GBPUSD has moved higher but the view remains that this represents US weakness more than GBP strength. The markets have been remarkably complacent on rising virus numbers. Specifically, in the UK, UK-China tensions continue to linger following the UK’s plan to offer immigration avenues to Hong Kong residents and the UK’s decision to put Huawei’s UK operations under the microscope. Economically speaking the UK remains balanced between optimism on an economic recovery and Brexit risks. With the deadline to request an extension to the transition period now officially passed, a skinny deal is increasingly seen as the best case scenario. Given this, both sides still remain far apart although both sides have agreed to intensified talks. Given this, it’s anyone’s guess where Brexit talks will head but it seems reasonable to expect volatility to pick up and sensitivity around negotiation headlines to grow as the transition period deadline approaches.
Like other currencies, the yen is stuck in crosscurrents through virus and economic measures as well as geopolitical factors. This leads to a bias for USDJPY to range trade in the near term as broader risk sentiment ebbs and flows. Should the yen breakout of its range, the bias remains for it to appreciate. Interest rates, on a real basis, should favor yen strength as Japan is facing disinflationary pressures. Additionally, infection news out of Tokyo shows rising infection numbers. Should infections continue to rise, this could drive yen strength through market risk-off although it is possible that if infections get bad enough it could spur further fiscal stimulus that could weaken the yen. The Bank of Japan also meets this upcoming week and is expected to be on hold.
USDCAD likely remains range bound in the near term. Notably, the loonie has underperformed its G10 commodity peers despite positive vaccine/treatment news that has supported risk sentiment. In Canada, high-frequency data shows that traffic is picking up and public transportation usage and restaurant bookings also ticking up. Fortunately for Canada, the country has been able to re-open without a major rebound in cases relative to other countries. These two factors suggest near term data should be positive and support the loonie however the Canadian economy remains uniquely vulnerable to COVID-19 impacts. The Bank of Canada also meets this upcoming week and is expected to be on hold.
The yuan broke below 7 this past week for the first time since March. Bullish sentiment has been building after strong PMI numbers and more recent equity strength. With geopolitical tensions between the US and China not a market concern near term, further support for CNY is possible but Chinese authorities are unlikely to tolerate much CNY appreciation. Over the medium-term skepticism is still warranted. Tough on China remains a campaign theme so expect the rhetoric to pick up again as we move closer to the US election.
The Aussie has been tied to risk markets and that isn’t likely to change in the near term. Markets continue to focus on re-openings. The economic rebound narrative has been supported by the market’s belief that any infection spike will be met with localized shutdowns and not the blanket closures we have seen. This should continue to support equities/risk assets which in turn represents AUD support. Over the medium term, the outlook is a bit different with high valuation and growing tailwinds building. The RBA kept its policy rate on hold this past week but continue to signal that further support is needed (fiscal and monetary).
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at -0.10%
Expectations for rates to remain unchanged at 0.25%
Expectations for rates to remain unchanged at -0.50%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Retail Sales MoM
Expectations for a 5.0% increase
US Initial Jobless Claims
Expectations for 1.25 million claims
U. of Mich. Sentiment
Expectations for a 79.5 print
EZ Industrial Production
Expectations for a 15.0% increase
UK Industrial Production MoM
Expectations for a 6.0% increase
UK Unemployment Rate
Expectations for a 0.3% increase to 4.2%
German ZEW Expectations and Current Situation Survey
Expectations for a 60.0 and -65.0 print, respectively
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