News & Analysis

The narrative of dollar weakness seemed to be the status quo this August, but the greenback managed to steady itself over the last week. A less dovish than expected set of FOMC meeting minutes provided a level of support for the dollar, despite growing concerns about the US economic recovery.

In the G10 space, sterling was the top performer despite the negative Brexit outlook for the UK, and the Japanese Yen came in at a close second, owing its rally to renewed US-China tensions and lingering virus concerns about the US and global outlook. This week’s calendar contains several highlights for markets to focus on in addition to developments in global risk appetite and the dynamics of the pandemic, with key GDP readings from Canada and Norway, along with the Jackson Hole symposium filled to the brim with central bank policy discussions.

Tuesday 24th:

The disruption to the Norwegian economy induced by Covid-19 is expected to weigh on Norway’s June and Q2 Gross Domestic Product figures released at 07:00 BST. Bloomberg does not provide a nation-wide forecasted median for the release, but the Norges Bank’s latest outlook published back in June saw policymakers revise up their forecasts for 2020 GDP to -3.5%. The median expectation for the mainland reading sits at -6.2% QoQ. The central bank has not published a new outlook since, but last week’s monetary policy statement emphasised that the recent data releases have largely backed up the GDP forecasts, while both crude prices and the Norwegian krone seem to have stabilised relative to the huge crashes seen earlier in this crisis. The German IFO reading will also be released on Tuesday at 09:00 BST and is expected to print at 98.1 for the expectations index, a slight uptick from last month’s 97.0 reading. The current assessment is projected at 87.0 from 84.5 in July, and the IFO business climate is expected to print at 92.4 compared to last month’s 90.5 – all suggesting improved expectations of the German economy. The IFO forecasts came in before the most recent PMI releases from the eurozone and have not been updated since. The disappointing headlines from the PMIs may provide a snapshot of the IFO reading as well, possibly indicating that the forecasts are too optimistic and will likely undershoot expectations.

Wednesday 26th:

Agenda includes July Consumer Price Index figures from South Africa at 09:00 BST. The month-on-month figure is expected to come in at 1.2%, up from 0.5% in June, while the YoY CPI is forecasted to print at 3.0% from June’s 2.2%. This will mark a return of inflation back to the SARB’s target range after June’s reading slipped below the 3% lower bound for the first time since 2005. Growth and inflation data in emerging markets hold more monetary policy implications than in developed markets, with the CPI undershoot arguably prompting the SARB to cut rates last time around.

Thursday 27th:

The finalised US Q2 GDP figures are released at 13:30 BST. If the forecast proves to be right, the annualised GDP is set to have increased to -32.5% from the preliminary -32.9%. This is nothing to write home about as it would still be the worst GDP slump on record dating back to the 1940’s, while the minor revision is also impacting substantially lagged data. With lawmakers arguing about a potential new round of government stimulus, much remains unknown about what comes next for the US economy. Thursday also features Federal Reserve Chairman Jerome Powell’s speech delivery at the annual Jackson Hole symposium on the central bank’s long-awaited monetary policy framework review. The event will be virtual this year and livestreamed to the public. More on Jackson Hole below. Banxico’s meeting minutes are also released at 15:00 BST and should provide little additional detail to last week´s policy announcement. After cutting another 50 basis points off interest rates in the August meeting, the Bank of Mexico still has ample room to ease policy further until accommodative rates are achieved. However, the path to a looser policy guidance looking ahead is far from clear. Albeit downwardly biased due to broad economic slack, risks to the inflation outlook remain highly uncertain. The undesired effects on the capital account and currency markets also prevent the central bank from aggressively easing policy due to the inflationary impact. As Banxico closely examines the economic response to previous stimulus, incoming inflation data will rather be a better guidance for market expectations on monetary policy. Bi-weekly inflation data will be released on August 24th, while Banxico’s quarterly inflation report is due after on the 26th.

Friday 28th:

Personal Consumption Expenditure figures from the US for July are set for release at 13:30 BST.  The latest Consumer Price Index readings from the US showed that inflation rose 0.6% month-on-month compared to the 0.3% consensus, while it rose 1.0% year on year vs the expected 0.7%. This inflation reading sits in line with expectations of the PCE reading, which sit at 0.4% MoM and 1.0% YoY. Despite inflation data having limited market impact in this current environment, with expectations of future Fed policy changing regularly ahead of Septembers meeting, where we expect the central bank to announce average inflation targeting at a minimum, the inflation reading may come back into the markets focus. Also released on Friday at 13:30 BST, Canada’s GDP is expected to have fallen 9.4% YoY, while the month-on-month GDP is forecasted to print at 5.2%. More on Canada’s GDP release below.

 

Jackson Hole schedule – more speakers likely to be announced in the run-up:

 

POWELL’S JACKSON HOLE SPEECH COULD SEND SELL SIGNALS FOR THE DOLLAR

The annual Jackson Hole Economic Symposium, hosted by the Federal Reserve Bank of Kansas City, will take place on August 27th-28th and will be held online for the first time in 40 years due to the pandemic. The event, gathering international central bankers, academics and relevant economists from the private sector, will focus on the theme “Navigating the decade ahead: Implications for monetary policy” and will be live streamed to the public. The meeting is typically a platform for significant policy announcements or shifts in the economic outlook, and therefore draws investor´s attention over the summer period. This time around, the Fed Chairman’s speech will hold all of the attention as hints on the long-awaited monetary policy framework review and Fed´s forward guidance are expected.

After holding back on immediate changes to the path of monetary policy in July´s meeting, the minutes of the FOMC revealed that the Bank is likely to strengthen its forward guidance on the back of a challenging recovery outlook. Markets have been increasingly pricing in the prospects of low real yields on the back-end of the yield curve, with a certain form of accommodative forward guidance expected at some point in the near future. The move, however, is strictly linked to the strategic review carried out by the Fed over the last year, aiming at re-anchoring market´s expectations on the inflation goal. The central bank first indicated a 2% inflation target in 2012, under which overshooting inflation expectations would prescribe restrictive monetary policy actions – a source of dollar strength. However, a lower-than-desired average inflation print of around 1.4% since the target was introduced suggests a softer goal around the target is recommended in order to re-centre investor’s expectations. As a result, the groundwork for lower-for-longer interest rates could be laid out, feeding the recent dollar weakness narrative, as the Fed is likely to outline its choice for a symmetric inflation target more commonly known as average inflation targeting.

Investors have been calling for further clarity on the Fed´s next plans, with much of the attention pushed back to the September FOMC meeting. The still uncertain scenario laying ahead, especially regarding the extent of the upcoming fiscal support package to be approved in Congress, provides some rationale to the Fed´s reluctance to release its policy review and commit to a new monetary framework.

This is also the main argument to our view that it might be premature for Powell to make a clear policy statement in the Jackson Hole presentation next week.

However, the event might be taken as a prepping exercise before the next scheduled meeting on mid-September, triggering an adjustment of market pricing ahead of a clear-cut policy announcement. Messages in this direction could come in the form of how the board consensus is evolving on the framework review, while probably deflecting on too specific a wording.

Whatever the extent of explicit forward guidance, the direction of Powell´s speech towards a looser policy stance should assure markets of their recent dollar downward bias. Implications for financial markets could be broad-base, potentially fuelling an even larger equity rally and dollar depreciation. EURUSD one-week implied volatility in futures market does not currently price in a strong upside move on the back of the event, which suggests ample room for downside dollar correction next week if Powell actually signals a shorter time frame for upcoming Fed´s moves or delivers a more explicit monetary policy speech.

 

One-week implied volatility for EURUSD price action leaves room for upside surprises on Powell´s presentation in Jackson Hole Symposium

CANADA’S Q2 GDP READING WILL PUT THE LATEST FISCAL MEASURES INTO THE MARKET’S FOCUS AS THE DEPTH OF THE CONTRACTION IS QUANTIFIED

With Statistics Canada pivoting from quarterly to monthly GDP releases, Canada’s Q2 GDP reading is released later on that other G10 peers first readings, mainly because it isn’t subject to as many revisions. With the economy growing by 4.5% in May, and expected to grow a further 5% in June according to Statistics Canada’s new flash estimates, GDP is set to contract by approximately 12% in Q2. However, owing to the preliminary nature of these estimates, a formal revision will be released in the shape of the official GDP reading for June and Q2 on August 28th at 13:30BST/ 08:30ET.

The Q2 data is undoubtedly going to register the worst economic contraction in Canada’s peacetime history as April’s -11.75% MoM contraction following March’s already negative reading weighs on the quarterly growth rate. Calculating this figure into an annualised rate will only exacerbate how big the economic contraction was. This is a ridiculous methodology given that this shock isn’t representative of a shift in the underlying growth rate, but does hold one advantage – the data now allows a direct comparison to the US Q2 reading. The advanced Q2 reading from the US came in at -32.9%, slightly lower than the 38.9% median expectation for Canada’s reading on Friday. This equated to a roughly 9.5% QoQ contraction in the US, highlighting that Canada’s quarterly contraction is likely to read better than the 12% contraction estimated by StatsCan last month. This is also reflected in the median month-on-month expectation of 5.2%, which is marginally higher than the statistics agency’s 5% MoM rebound. Reverse engineering the median expectation of the annualized rate (-38.9%) suggests that economists’ expectations sit at -11.59% in QoQ terms.

Despite the high probability that Canada will record greater economic damage in Q2 than the US due to more stringent lockdown measures, the continuing outbreak in the US due to the hasty easing of lockdown measures means that the Canadian recovery will lead its North American counterparts.

This is best reflected in the latest USDCAD price action, with the loonie now trading at levels not seen since January of this year as opposed to pre-virus levels of 1.34.  In addition, the economic damage suffered in Q2 is expected to be less than that recorded in most of Europe. Although some of this can be attributed to the outbreak occurring later in Q2 in Canada, and thus the effects are likely to spill over more into July’s reading in Q3, it may also show the lessons learnt by limiting the economic damage through a swift containment policy.

 

Canada’s Q2 contraction is set to be worse than Germany’s but better than the rest of Europe’s, if the Bloomberg median estimate is correct

 

With fiscal measures in full swing by June and the economy largely beginning to open up, Friday’s GDP data is likely to show the peak level, if not close to the peak level, of month-on-month growth, largely due to base effects. For this reason, and due to the lagged nature of the data, the GDP reading may prove inconsequential to the loonie in a direct sense. Instead, the data point will cast a light on the effectiveness of the fiscal policy measures implemented in driving the economic recovery now the depth of the contraction is quantified. This comes at a crucial juncture for markets, with participants only just coming to terms with the latest ministerial appointment of Deputy Freeland as Minister of Finance, along with the latest announcement that the CERB scheme will be extended by four months. With Justin Trudeau’s carte blanche on fiscal spending coming to an end with Canada’s parliament reconvening in September, the implications of Friday’s GDP reading for fiscal policy making set to take place under greater scrutiny will likely be the driver for the markets’ price action. With the budget deficit at 16% of economic output, excluding the latest C$37bn expenditure on labour market measures, it is unlikely that parliament will let this kind of fiscal spending continue at such a pace. If this is the case, it only increases the pressure Freeland will be under in the position of Finance Minister, especially if the economic recovery doesn’t meet projections.

 

Canada’s Q2 GDP release set to mark the biggest quarterly contraction in peacetime history

 

 

Authors:
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, Junior FX Market Analyst
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