Morning Commentary: The Problem with Base Effects

Foreign Exchange - Morning Commentary
The Problem with Base Effects 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
After a dismal Q2, Q3 GDP looks very strong.  The Bloomberg consensus for quarter-over-quarter (QoQ) GDP growth and consumption growth came in at 18% and 24%, respectively.  If market consensus proves to be right, it will be the strongest QoQ growth since the 1940s.  Sadly, it seems that every bit of positive news these days seems to be accompanied by looming storm clouds.  

While there are expectations for strong QoQ growth, the monthly growth numbers are effectively zero.  This is because there was a surge in activity in May and June.  Strong growth at the end of Q2 means that economic activity ended at a much higher level than the quarter average.  If you compare what markets are expecting for monthly consumer spending from July-September to the monthly level in June as opposed to the quarterly average, you find the markets are actually expecting a slight monthly contraction intra-quarter.  

The reason for this isn’t surprising.  The surge in economic activity in May and June partially reflected pent up spending from the shutdown.  Additionally, there was likely some benefit from spending as people adapted to working from home.  As with general pent up demand, once home office and home entertainment equipment has been purchased, spending should drop.  

Fortunately, the pullback in economic activity due to rising infections is different from the spring when infections triggered blanket shutdowns.  The public has become more accepting of the trade-off between health issues and a more open economy.  The hope is that greater acceptance of modest steps, such as mask wearing and social distancing, will allow the country to better control the spread of the virus without blanket shutdowns and slowdown in economic activity that come with spikes in infections. 
  • US initial jobless claims dropped to a new pandemic low of 1.2 million claims.  This positive surprise came on the back of yesterday’s dismal ADP jobs report.  The official government jobs report is scheduled to be released tomorrow morning. Continuing claims fell to 16.1 million from last week’s revised 17.0 million but still remain elevated.   
  • US negotiations on the Phase 4 stimulus plan continue.  Republicans have moved up their proposal for enhanced unemployment benefits to $400/week but Democrats remain firmly at $600/week.  The Senate has postponed its August recess and will remain in session next week as it attempts to reach a deal.  
  • The Bank of England delivered a less-dovish-than-expected hold in a unanimous decision.  The bank also stated that it expects its bond purchases to end by this year.  On negative rates, Governor Bailey said the bank was studying the suitability and found it not to be appropriate now but possibly in the future.  GBP is up on the decision as some in the markets were hoping for hints of a rate cut or a possibility of negative rates but has subsequently given up roughly half of its gains.
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