Last week’s trading session was dominated by broad USD weakness in the G10 space, with EURUSD hitting a 25-month high despite GDP contracting 15% QoQ in Q2 and USDJPY falling below 105 for the first time since global financial conditions normalised.
The question on market participant minds remains whether the dollar has much further to go as short USD trades become crowded, but we argue this depends on the progression of the domestic Covid outbreak. Additionally, Covid cases rising in parts of Europe, Tokyo and Victoria could prompt the dollar to find support from the risk environment deteriorating in a broader sense as opposed to risks being isolated to the US economy.
While the progression of Covid is monitored closely, key data points such as Nonfarm payrolls, central bank meetings in Australia, Brazil, the UK and India and eurozone retail sales are in focus.
China Caixin Manufacturing PMI is released at 02:45BST. The Caixin measure tends to focus more on private east coast manufacturers compared with the larger enterprises surveyed in the official PMI release. That being said, the dynamics in the PMIs look similar. Last week’s official manufacturing PMI of 51.1 showed that the rebound in the sector is steadying with non-manufacturing set to take over the economic recovery. New export orders remain a drag on the recovery in the manufacturing sector, despite a pickup in domestic new orders, while employment levels remain contractionary. It will be interesting to see if this is mimicked in the Caixin reading. If so, we may start to see manufacturing growth flat line in China. At 10:00BST the ABSA manufacturing PMI is released for South Africa. As referenced in our latest ZAR outlook, a strong reading in the PMI shouldn’t be read as growth in the industry on an annualised basis, but merely an increase in output relative to the month prior. The PMI will be key in gauging the speed of the recovery in the manufacturing sector, which accounts for almost 13% of GDP, after lockdown measures were eased on June 1st. With electricity production stabilising of late, another strong reading for July will signal that South Africa’s economy is starting to show a sustained recovery rather than an initial bounce due to the scaling back of lockdown measures. The previous reading of 53.9 for June sat near a seven-year high for this reason. Mexico IMEF manufacturing and non-manufacturing indices, released at 18:00 BST for July will likely continue to signal a mild resumption of economic activity in the Mexican economy compared to April’s record slump, but will remain far below already depressed pre-virus levels. Leading indicators for both sectors are likely to continue, in line with the upward path taken since the April bottom, but well below the 50 level indicating expansion. In the June reading, both indexes were still below the lowest value during the GFC in 2008. These indicators are likely to remain subdued in July since the stringency level of the containment measures hasn´t varied considerably during that period and Covid cases in US border-states have triggered additional restrictions. The Mexican economy plummeted a record 17.26% in Q2 on a quarterly basis and prospects for a rapid recovery are slim.
Australian retail sales for Q2 are released at 02:30BST with the RBA announcing its latest monetary policy decision at 05:30BST. With policy already at its lower bound and a consensus still seemingly against negative rates, no policy action is likely to be forthcoming from the RBA this week. Although Australia experienced a moderate economic contraction in Q2 when compared to the US, renewed restrictions in Victoria suggest that the economy is not in a full New-Zealand re-opening yet. Philip Lowe once again reiterated his opposition to negative rates in a speech, and perhaps came the closest of any central banker to making a hawkish statement by warning of “limitations to what more can be achieved through monetary policy”. Friday’s Statement on Monetary Policy is unlikely to depart from these positions. Instead, the RBA’s forecasts will be the main focus, particularly in light of the recent worsening in virus cases. Up at 08:00BST is Turkey’s CPI data for July. With the central bank holding rates at 8.25% since May’s meeting and base effects waning, Turkey’s CPI data is starting to come back into focus yet again as inflation pressures tick up. June saw inflation jump from 11.4% to 12.6% due to higher food prices and energy costs. This impact may begin to fade, however, as oil prices stabilize just above $40 per barrel and the lira also steadies below the 7.00 level. Domestic disinflationary forces may begin to prevail, but the risks of a higher path for inflation and limited monetary policy adjustments are highlighted by the CBRT’s latest decision to raise its inflation forecast from 7.4% to 8.9% for 2020. Canada manufacturing data for Q2 is also due at 13:30 BST. In June, the PMI rose from 40.6 to 47.8 with the proportion of respondents indicating a monthly drop in production falling from 47% in May to 30%. However, the main concern for businesses is subdued demand and widespread concerns about the global economic outlook. With export sales decreasing at a faster pace than total new orders, July’s data point may show if the US outbreak is weighing on the rebound in Canada’s manufacturing sector.
the day kicks off with the remainder of China’s Caixin PMI’s for July, including the overall composite reading, at 02:45BST. Similar to the manufacturing reading, we expect the services PMI to do much of the heavy lifting in China’s recovery in Q3. Expectations of future work remain elevated in the service industry and we see this continuing. Expect another elevated services PMI, but maybe not as high as June’s 58.4 because base effects now play a role. Additional key data points for Wednesday’s session are eurozone retail sales for June at 10:00BST and the BCB’s announcement of the Selic rate in the evening. Further details on both events are below.
The Reserve Bank of India kick off proceedings on Thursday at 07:15BST and despite inflation averaging above 6% for both Q1 and Q2 (Q1 average: 6.67%, Q2 average: 6.53%) we anticipate that it won’t be enough to put off the central bank from further cuts. The median estimate supplied to Bloomberg is a 25bps cut, bringing the repo rate to 3.75%, which doesn’t seem unrealistic given the economic toll inflicted by the continuing outbreak in India and the transitory factors driving inflation. Food inflation drove the headline rise due to supply-chain constraints but has shown signs of subduing as lockdown constraints ease. The Bank of England is then up at 12:00BST – see section below. Finishing off the day’s data is initial jobless claims from the US at 13:30BST. Initial claims have been trending up over the second half of July as the domestic outbreak begins to unwind the recovery initially seen in the labour market. Continuing claims have also risen in line with the rise in initial claims. The data point will be in scope ahead of Friday’s NFP release for July.
Following the decision earlier in the week, the Reserve Bank of Australia release their monetary policy statement at 02:30BST. Mexican CPI for July is then scheduled at 12:00BST Finishing off the week, markets get the latest information from both the US and Canada’s labour market at 13:30BST. While the US Nonfarm Payroll data will draw the majority of the markets focus given the ongoing domestic outbreak and recent rise in claims data, the Labour Force Survey out of Canada will be illustrative of how Canada’s labour market has reacted to the scaling back of lockdown measures. With the CERB scheme set to end in October and the CEWS scheme supporting less workers recently, the labour market data may shed some light on how deep the scarring of Canada’s labour market is.
Latest data from the CEWS scheme shows the number of applicants winding down, is this a trend or will it pick back up now lockdown measures are scaled back?
Eurozone retail sales for June at 10:00 BST on Wednesday
The impact of the eurozone’s corona-crisis was finally quantified on Friday when Q2 GDP figures showed the largest quarterly decline in eurozone output since records began in 1970. Wednesday’s retail sales data are expected to paint a more positive picture than the GDP data. The retail sales data are monthly, and by June, the reporting period, the worst had likely passed. Most eurozone countries were still in lockdown in April and May but gradually opened up in June. While May’s MoM reading came in at a staggering 17.8%, most of this was the initial rebound due to partial loosening of lockdown measures. The YoY data for May still printed in negative territory as the level of purchasing remained substantially off the pace of pre-pandemic levels.
Given the increased easing of lockdown measures in June, we expect an improvement in the retail sales YoY data.
Month-on-month retail sales are expected to have increased by 6.8%, extending May’s rebound, while the yearly sales are forecasted to print at 0.4%. Better than expected German retail sales that were released on Friday rose at an annual rate of 5.9% following a 3.2% rise in May, showing that the relaxation of lockdown measures is the key driver of recovery in consumer spending. However, it should be noted that Wednesday’s eurozone retail sales should not be seen as a flawless proxy for the eurozone’s recovery path. The data was gathered over the month of June, when even the hardest-hit countries had reopened up, but accelerating daily infections in Spain have caused some of the key growth areas to go back into lockdown again since last week, increasing fears of additional localised lockdown measures being imposed in the euro-area as a whole and thus disrupting the path of the recovery.
Eurozone countries with accelerating virus cases
BCB to provide a last aid while the covid situation in Brazil is far from under control
The Central Bank of Brazil is expected to throw one of its last life jackets to the Brazilian economy in its next monetary policy meeting on August 5th. We believe the Bank will slash another 25 basis points off the Selic reference rate, leaving the benchmark at a new historic low of 2%. Given the recent better-than-expected inflation prints, especially core, we expect the BCB to end the easing cycle with this last policy move, after practically exhausting any room for further use of the traditional instrument. Marginal policy tools remain in the form of quantitative easing after Congress granted operative power to the central bank to expand its asset purchases. However, BCB chief Campos Netos has repeatedly stressed that quantitative easing powers are intended as a market stabilization mechanism instead of an alternative form of monetary stimulus, which leads us to believe this is only a last-resort policy choice.
Prospects for monetary normalization are delayed until the end of next year according to implied pricing in money markets, while expectations for the inflation path remain benignly trending towards the bank target. Recovery projections for the Brazilian economy in 2021 are pessimistic when compared to the forecasted decline this year, with IMF estimates suggesting a 3.6% recovery after a 9.1% contraction in 2020. From this point onwards, however, there is little the BCB can do to counter the economic damage inflicted by the pandemic. The latest bank lending data showed that overall credit conditions are broadly accommodative, with lending rates to both corporate and individuals steadily declining as a result of BCB easing measures. Additionally, credit growth has also been boosted by alternative capital-markets-based funding sources, adding to overall improved financial conditions.
BRL has modestly benefited from reduced stress in financial markets, while mainly advancing on the back of broad dollar weakness.
Added monetary stimulus will do little in reverting this trend as the move is already priced in by markets. On the contrary, any potential BRL surge is also limited, considering the numerous risks the Brazilian economy faces ahead. The alarming pandemic situation in the country poses increasing challenges to the economic rebound in the second half of the year, while political instability is an equally serious detrimental factor for investors. With the debate over the spending cap ongoing, the lack of reinforcement of fiscal support could compromise the earlier-than-expected inflation gains.
Policy action unlikely as MPC reckons with significant downgrades to growth in Monetary Policy Report
With the UK economy recovering and undergoing a halting re-opening, the MPC is unlikely to change interest rates or any other major policy settings at Thursday’s meeting. Instead, the occasion will be a chance for markets to assess how optimistic the MPC is about the coming quarters, and the state of the Committee’s thinking on what additional easing measures could be taken if necessary – most importantly, negative interest rates.
A few things to look out for from Thursday’s releases:
- How the MPC’s expectations and assumptions about future growth have changed since May. At the May Monetary Policy Report, the MPC were happy to make a series of fairly optimistic assumptions about the medium term outlook for the UK economy. In the “illustrative scenario” that replaced the usual economic forecasts, the MPC envisaged a relatively rapid recovery in the UK economy in 2020 and 2021, where medium term “scarring” to the economy from unemployment and lasting drags to consumer behaviour largely dissipated by next year. The scenario also assumed that restrictions from Covid-19 on economic activity would be gone by the end of Q3. The latter assumption now no longer seems tenable, and the former may be reassessed, although the minutes of June’s meeting were at least moderately optimistic about consumer spending, and the housing market. The MPC may also advance a new model for measuring the marginal cost of regional lockdowns and restrictions on dining and hospitality. Finally, it’s likely that the MPC will stick to its “illustrative scenario” approach to formal forecasting.
- Talk of negative rates. Over the last 6 months negative rates have gone from something the MPC had practically ruled out to a possibility that has not yet been warranted or fully explored. Recent comments from Ben Broadent and Andrew Bailey suggest that negative rates may come under consideration in the event of a slowdown in growth. Bailey recently said the option was under “active review”, while also highlighting the fact that half of the challenge would be communicating the policy to financials and consumers.
- Andy Haldane – or his ideas, at least. The Bank of England’s Chief Economist voted against QE expansion and showed noteworthy optimism about the UK economic outlook in a recent speech, based on a selection of alternative data sources. With the assumption that restrictions on economic activity will be gone by the end of Q3 now looking seriously dubious, commentary on alternative data and the nature of the MPC’s discussion in meeting minutes will interesting.
GBPUSD rallies as US dollar takes beating
Non-Farm payrolls are a central feature of the global economic calendar because of their status as the timeliest official data for the US economy. Friday’s print will be all the more important for this reason: it will be the first traditional data release to show the effects of a likely slowdown in the US recovery. Higher-frequency and alternative data suggest that after a strong bounce in June, consumer spending growth in the US is likely to have slowed significantly, damaging the prospects for a “v-shaped” recovery in the US economy as a whole. The FOMC is clearly tracking these alternative data and has concluded the pace of recovery is likely to slow significantly, as Jerome Powell noted at last week’s press conference. However, last week’s meeting also showed the Committee was unwilling to act until hard data confirming the slowdown were available. A large slowdown in Friday’s jobs report will likely be taken as further confirmation by markets that the Fed will indeed deliver a flatter, lower US yield curve well into the future.
Forecasts submitted to Bloomberg for the headline number are widely distributed around a median of 1.635m jobs added in July. We believe risks are tilted solidly to the downside of this number, for several reasons. 4.8 million jobs were added on net in June, almost 3m of which were in leisure, hospitality, accommodation, and other sectors vulnerable to renewed restrictions of the sort that have been imposed since June. The high proportion of re-hires in these sectors in June, which likely bore the brunt of any slowdown in growth since then, suggests that the pace of job gains is likely to have slowed significantly in July. Weekly initial jobless claims have begun to accelerate, and rose to 1.434m on a seasonally adjusted basis last week, compared to 1.31m on the week of 3rd July. Non-seasonally adjusted data were less worrying, but in our view, the trend suggests a slowdown in the rate of the labour market recovery. Considering the sustained rate of jobless claims, re-hiring would need to remain implausibly strong to see anything resembling the 4.8m jobs created in June.
Will the extended outbreak in the US be a USD or North American story?
Last week’s trading session was dominated by broad USD weakness in markets, but the loonie failed to capitalise on this. USDCAD tested the 1.3330 level on Tuesday, Wednesday and Thursday, failing to break it on every occasion. Similar lows were also seen back in early June just before the Canadian dollar sold-off and USDCAD returned to the 1.36 level.
This then begs the question, is the Canadian dollar poorly positioned to benefit from structural USD weakness?
The initial signs suggest yes. This isn’t just reflective in how USDCAD has traded relative to other G10 FX pairs, but also on a more structural level. If the dollar is selling off due to isolated risks, namely the continuing outbreak of Covid-19 in the Sunbelt area, which are weighing on the expected economic recovery, then this quickly becomes a North American story. The reason is all to do with Canada importing this slower economic recovery. The US accounts for more than 60% of Canada’s exports and a sluggish rebound in economic conditions in the US could quickly weigh on Canada’s trade balance.
Canada’s export levels to the US nosedive as trade is redirected to the rest of the world. This could become a growing theme as the US economy struggles to contain the domestic outbreak and begin a sustained economic recovery
Additionally, the continued outbreak in the US is weighing on expectations of the recovery in demand conditions as additional lockdown measures could be forthcoming. This has been weighing on crude oil pricing, capping WTI at little over the $40 per barrel mark. This was most telling on Wednesday when the Department of Energy reported the largest decline in US crude inventories in 2020 with a draw of 10.6m. Despite the record draw, inventories of distillates and gasoline still rose, highlighting the concerns of a limited rebound in demand. Ultimately, WTI failed to react too positively to the DoE release and actually fell back below $40 the day after on renewed concerns over demand conditions. With OPEC+ set to scale back their demand cuts in August, a suppressed oil price may continue to weigh on Canada’s oil industry. Although we argue that this has a limited impact on Canada’s economic recovery compared to the export dynamic to the US, as Canada’s oil industry is slow to react to recovering oil prices as the industry nurses its collective balance sheet, it still has ramifications in the currency market. The two-pronged risk factor suggests to us, initially at least, that the loonie may struggle to join its G10 peers in rallying against the dollar should the current source of USD weakness stem from expectations of a more protracted US economic recovery. For now, the $1.3330 level of support remains key for the pair.
USDCAD found support at 1.3330 last week during multiple trading sessions
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, Junior FX Market Analyst