News & Analysis

The broad dollar was put on the back foot this week, as virus counts rose in several key regions and markets received a true wild-card in the form of Donald Trump’s infection with covid-19 on Friday. With less than a month to go before the US election, the possible ill-health of the US President is a uniquely difficult to quantify risk, especially given the highly centralized nature of the administration and the wider GOP political system.

Due to the looming US election and possible illness of Donald Trump, the greenback will likely remain the fulcrum for wider global macro market sentiment next week. Last week’s non-farm payrolls report showed permanent job losses rose by more than 300,000 in September and now total more than 2.5 million since February. Labour force participation fell further as discouraged workers stopped looking for jobs, having initially showed an encouraging increase from April’s lows. Both of these developments suggest serious long-term damage to the labour market is occurring beneath the surface of the encouraging headline figure. With the President facing covid-19 and fiscal stimulus talks stalled, the report highlights the high stakes facing the US economy amid political uncertainty in Q4.

This week’s calendar offers several important looks at both Fed and ECB policy, while Brexit negotiations will likely continue after a high-stakes call between Boris Johnson and Ursula von der Leyden.

 

MONDAY 5th

The data calendar kicks the week off with Turkish CPI data for September due at 08:00 BST. Inflation has been a concern for DM central banks since the financial crisis, prompting the Federal Reserve to shift to an average inflation targeting framework in order to lift inflation expectations. In comparison, the Central Bank of the Republic of Turkey (TCMB) has the opposite problem. After a credit binge in response to the pandemic’s outbreak, the Turkish economy is about to start paying the price, in the form of rising inflation. The main source of inflationary pressure will come from sustained lira weakness, but loose monetary policy in real terms is likely a contributing factor. After the TCMB hiked interest rates by 200bps only last week, the trajectory of inflation will be closely watched to help guide expectations of future monetary policy.

The focus of the data calendar then shifts to the eurozone, with the release of September’s PMIs from Spain and Italy at 08:15 and 08:45 BST, while final PMI readings from France, Germany and the eurozone as a whole are released at 08:08:50, 08:55 and 09:00 BST respectively. September has seen a mild reversion in the recovery in the eurozone, with the service sector struggling with the resurging Covid cases. Even with eurozone composite PMI holding on above the breakeven 50 mark, it has become clear that the sharp summer recovery is set to fade amid a new round of containment measures ahead of the winter. Differences across sectors and countries abound, with Germany leading the strong manufacturing recovery while services are taking the heavier toll in Spain. September’s PMI data for Germany and France highlighted these gaps, with French services dropping to 47.5 from 51.5 previously and Germany´s sliding from 52.5 to 49.1. Next week data for Spain and Italy is poised to showcase more gloom, as both countries have showed a serious impetus in infection cases over the last weeks, prompting the imposition of further restrictions.

 

PMI data in the eurozone to reflect a halt in the recovery path

Attention then turns to the UK, with the release of the final services and the composite PMI reading at 09:30 BST. This week’s final reading of the manufacturing PMI saw output slip slightly below expectations, printing at 54.1 vs a preliminary estimate of 54.3, a theme that may be mirrored in the final reading of the Services PMI, which currently sits at 55.1. Brexit uncertainty is already starting to show in certain survey responses, with the early signs of stockpiling seen in the manufacturing release. This will likely begin to arise in the service sectors business outlooks, further weighing on investment and employment intentions which are already weak due to the impact of the pandemic. However, with trade talks approaching the endgame and GDP released later in the week, the PMIs are highly likely to remain out of the market’s focus, especially as they’re yet to show a substantial cooling in the economic rebound at current levels. Eurozone retail sales data for August then rounds of the days data at 10:00 BST, with consensus expectations pointing to a continuation in the recovery at 2.4% both on a monthly and yearly basis. Private consumption has remained strong amid support from furlough schemes and favourable credit growth. August figures may still provide the strong signal from the economic recovery during the summer, setting a strong base for the months to come. Looking ahead, however, expectations are poised to disappoint to the downside in light of the surging wave of infections and restrictions to economic activity.

TUESDAY 6th

The latest monetary policy decision by the Reserve Bank of Australia at 04:30 BST will likely see Deputy Governor Debelle’s speech rehashed, while both the cash rate and 3-year yield target is held at 0.25%. On the 22nd of September, Guy Debelle spoke on the Australian economy and monetary policy to the Australian Industry Group. The virtual speech outlined to markets that the RBA was still open to easing monetary policy further, with Debelle’s tone suggesting further rate cuts and QE would be preferred over negative or FX intervention – something that the neighbouring RBNZ are more likely to embark upon. The speech by the Deputy Governor may be the start of a mildly dovish turn by the RBA, with many now expecting further easing to occur this year. However, Tuesday’s meeting is unlikely to see the cash rate fall further (still in positive territory) or the RBA’s balance sheet to expand at a more rapid pace. The central bank is likely to abstain from loosening policy until its November meeting for a multitude of reasons. Firstly, by November the nature of the global economic recovery will be clearer as the Northern hemisphere enters the colder winter months and virus cases naturally tick higher. Secondly, by November the RBA will be able to accommodate the Commonwealth budget due on October 6th, alter policy with updated forecasts and further prime markets for a further loosening with the Governor’s speech on October 15th.

German factory orders in August might provide some respite to the euro on release at 07:00 BST as the data may still signal hope from the resilient manufacturing German sector.

The robust manufacturing PMI pointed to a solid recovery at the end of Q3, lifted by output but also by rising new orders, which rose by the fastest pace in two-and-a-half years. The strong manufacturing sector is now the cornerstone of the Eurozone recovery, therefore attracting much more market attention than ever before. With services now clearly dampened by upcoming restrictions, the manufacturing sector is also set to boost employment in the area. German factory orders plummeted in April by 26% month-on-month, only to fully recover two months after. Since the sharp increase in June of nearly 28% month-on-month, growth in orders has been moderating to a more stable rate of 2.8% in July. Median expectations for the August print points towards a 3% MoM increase, which is still notably strong compared to the 0.23% average monthly growth over the last decade. Orders remain subdued on a yearly basis, but the next reading may place orders only 3 percentage points away of a full recovery should the consensus view proves correct. These data should be consistent with a 2.1% monthly growth on German industrial production in August, to be released the day after.

Following on from Monday’s PMI release, the UK Construction PMI for September is due at 09:30BST. Again, the data release is likely to be overshadowed by Brexit headlines. Given August’s dramatic slowdown in the construction sector, where the PMI slipped from 58.1 to 54.6, another dramatic plunge, especially below 50 to signal a contraction in the construction sector, may force markets to take notice. In August, the civil engineering sector slumped back into contraction and growth in commercial and housebuilding sectors slowed, a theme that is likely to continue as the economy remains mired with uncertainty. Additionally, a reduced catch-up effect is likely to continue to weigh on the overall reading, especially as last month signaled shortages in new work.

Wednesday 7th

Norway industrial production is scheduled for release at 07:00 BST. In the absence of a forecasted median provided by Bloomberg, the prior releases and headlines around Norway’s industrial output may paint a picture of August’s figure. In July, the month-on-month index printed at 2.5%, which was the first positive change seen since April. The year-on-year figure that was adjusted for working days printed at 7.4%, well above June’s figure of 3.1%. In terms of related indicators, the manufacturing Purchasing Managers’ Index increased in both August and September, with September being the first time since February that the index dipped above the expansionary 50-level again. Norway’s regional network survey, which is the central bank’s primary sentiment gauge and tracks the general state of the economy and businesses, also rose from -2.63 in May to 1.47 in August. The survey indicated that businesses overall expect growth to pick up over the next three months and six months. The related indicators may suggest that industrial output is set to pick up as well, but there is a downside risk to output in the near term. The Norwegian Oil and Gas Association (Noga) stated last week that the first of four sets of pay negotiations for roughly 7,000 offshore workers have broken down. Hundreds of Norwegian offshore oil workers demonstrated as a result. Noga said that the strike could force a shutdown of six fields that represent a total output of 330,000 barrels of oil a day, or 8% of the country’s total petroleum output. The recent escalations around the Norway oil strike will however not be included in the industrial production figure of this week, as the figure will only cover August.

FOMC meeting minutes 19:00 BST. The last six weeks saw the Federal Reserve pivot to an average inflation targeting framework and implement a triple lock on lower rates for a sustained period of time – unemployment and inflation targets were specified as prerequisites for a policy change. However, the US central bank stopped short of providing markets with explicit forward guidance on its quantitative easing programme, while commentary from Chicago Chair Evans suggested the US central bank could still hike interest rates with policy remaining in accommodative territory.

The mixed messages progressively became clearer for markets, but questions over the Fed’s QE programme and the details of the average inflation framework remain.

While the Fed has decided to keep optionality with its forward guidance, markets will continue to scour any external publications like the September meeting minutes to build out monetary policy expectations. Given the last set of meeting minutes discussed the divergence of opinions over calendar based and event based forward guidance, further clarity on which way the consensus within the FOMC swings may be outlined in September’s minutes.

THURSDAY 8th

China’s composite and services Caixin PMIs will be released at 02:45 BST and are set to extend the theme set by last week’s PMIs. That is, the recovery remains robust and has actually become broader based than previously. In the official and Caixin manufacturing PMIs, new orders and new export orders rose more than production, suggesting more room for production to expand over the coming months. While this dynamic is at the mercy of external demand conditions, which are likely to ease over the coming months, the outlook for the Chinese recovery suggests stimulus measures may begin to ease.  The focus then shifts to Germany´s trade balance for August, which will open Thursday’s European session at 07:00 BST, with median expectations signalling a slowdown in the recovery of the trade balance to €16bn from €19.2bn in July. While the balance has recovered notably fast from the April collapse, the growth of imports still surpasses the speed of exports, pointing at major challenges for the European external sector. Two main issues poisons the view of a strong trade balance in the months ahead. First, with external demand likely collapsing on the back of the new surge of coronavirus infections, the risks for export growth are tilted to the downside. Second, even if the euro points at a weaker year-end than previously expected, concerns on the dampening effects of a strong currency may weigh on soft exports growth looking ahead.

 

Imports growth still outpace the speed of exports in the Eurozone trade balance

The focus will remain in the eurozone for the remainder of Thursday with the release of the ECB meeting minutes at 12:30 BST. The ECB minutes of September’s meeting will be closely analysed for any clues about the eurozone’s deteriorating growth and the inflation outlook, as ECB President Christine Lagarde gave no signs of heightened concern around these topics at the press conference. The central bank’s monetary policy stance remained unchanged, although the inflation outlook for 2021 was revised slightly upwards from 0.8% to 1.0%.

The ECB must reckon with Friday’s disappointing inflation print, as headline inflation in the eurozone fell to -0.3% YoY in September from -0.2% in August, while the core rate fell to 0.2% vs the consensus of 0.4%.

The low inflation figures did not come as a total surprise, however, as Consumer Price Index releases from Germany and Spain also sat in negative territory earlier in the week, with low energy prices and the German VAT cut being important drivers of the release. With the low rate of inflation, a rapid increase in the index would be necessary to meet 2021’s ambitious forecast of 1.0%. The ECB’s Chief Economist Philip Lane suggested that the Governing Council is watching fall in inflation closely, and said that the next step is to ensure ECB measures stimulate inflation. If not, policy makers are ready to add more stimulus if needed. ECB Executive Board member Isabel Schnabel said, however, that she sees no reason to add more monetary stimulus at the moment, as the incoming data supports the baseline. Governing Council Member Peter Kazimir stands on her side and argued that the central bank should wait until it gets a better picture of how the euro-area is developing to see if more stimulus is needed. Kazimir stated that the July numbers are not too revealing about the future, and that the figures until September are needed to understand the current economic state of the eurozone. He has made no related comments after the release of September’s inflation figures.

FRIDAY 9th 

Norway’s CPI data for September is set for release at 07:00 BST with expectations sitting at 1.8% YoY, just above August’s 1.7%, while the YoY core inflation is set to print at 3.6% down from 3.7% in August. Both are well above target, but the appreciating krone and low wage should moderate the rate of inflation according to the Norges Bank’s latest statement. Prices on services rose nearly 3% in August, while prices on imported consumer goods surged 4.6%, indicating that the drop in NOK explains a large part of the high inflation figures over the summer. The central bank explained that the current low rates are supporting Norway to work its way out of the sharp economic downturn caused by the pandemic, but a long period of low rates can still create financial imbalances. Regardless, the Norges Bank plans to keep its policy rate at the current level for the next couple of years and expects a gradual rise in activity to accompany the rate forecast. Should the inflation rate print higher than expected, this would have less bearing on the interest rate path of the Norges Bank or outlook for monetary policy in general, as policy makers already acknowledged that elevated core readings will be offset by a stronger krone and low wages.

 

Norway’s MoM CPI dropped in August while YoY figures saw continued pickup

To finish up the week prior to the long weekend in North America for thanksgiving, Canada’s labour market data is released at 13:30 BST.  After data from August showed what is expected to be the last bumper rise in employment, with 245,800 jobs added, the structural damage to the labour market will become more visible in the coming months. While September’s data will still show the effects of the CERB and CEWS schemes, the initial rebound in the labour market from looser containment measures has largely played out. We expect employment gains to slow substantially for this reason and to continue their concentration in full-time employment, where 205,800 jobs were added in August. In the coming months, policymakers’ focus will primarily be on the progression of the labour market recovery, due to the risks associated with structurally high unemployment levels at a time government transfers to households ease. While some of the holes in the social safety net have been plugged with the C-4 bill, subject to its safe passage through the Senate in the near future, the removal of what was basically a backdoor universal income scheme will still take a toll on the economy. The size of the impact and the underlying level of scarring in the labour market will become increasingly more visible as the economic recovery matures and support measures are eased, which won’t be for some time. However, in the interim, the natural slowdown of the labour market rebound is set to be a dominating dynamic for employment data.

 

GBP

THROUGH THE TUNNEL OR INTO THE BIN?

As this week’s headline roulette proved, the outcome of UK-EU trade talks remains the dominant driver of the near-term sterling outlook.  As avid sterling watchers, the minutia of negotiations and the likely outcomes are of primary interest when judging the likely path of the pound over the coming months, and the events of this week and next are no exception. The two most important questions are: what will the likely outcome of talks be, and how will sterling react? Our house view on sterling remains that the likeliest outcome is a free trade agreement that avoids a disruptive exit from the transition period in 2021, and on balance, this has been reinforced by the week’s events – although a significant risk of no-deal Brexit remains.

A cursory look at Thursday’s chaotic news flow and the ensuing price action offers hints at the answers to both questions:

  • At around 8:40 BST initial headlines from Reuters reported that the EU and Britain had failed to close their differences on state aid, a crucial sticking point in trade talks. Sterling began to weaken rapidly.
  • This was followed from 9:30 BST onwards by Ursula von der Leyden announcing the EU had commenced a legal infringement process against the UK.
  • The FT’s Sebastien Payne cites “officials in London” in stating that a “landing zone” has been identified on the issue of state aid. Sterling rallies.
  • The above report is promptly denied by EU officials, once again speaking anonymously via Reuters. The pound duly sold off.

 

Sterling rides Brexit merry-go-round as EU and UK officials’ engage in anonymous media briefing spin-off

One interpretation of this spin-off is that the two sides are indeed converging on the crucial issue of state aid, but that high-level political approval is needed for the final concessions necessary from one or both sides. This interpretation seems more plausible in light of the fact that Michel Barnier and David Frost will provide no briefing on this week’s final round of scheduled trade talks, and the announcement of a high-level call between Boris Johnson and Ursula von der Leyden on Saturday.

Based on the outcome of this call – and the undisclosed progress made in this week’s trade talks – sterling is in for a volatile open on Sunday evening and Monday morning. Key questions for Johnson and von der Leyden’s call, as well as EU and UK officials in general next week, are:

  • Will negotiations move to an intensive “tunnel” phase? This final phase of negotiations is designed to resolve final difficult issues. A move to this phase would be taken as a significant positive for sterling, and in our view would be worth another leg of 1-3% higher depending on how positive any accompanying rhetoric was.
  • If negotiations fail to move to the tunnel phase, will any clarity be offered on possible “landing zones” for issues such as state aid and fisheries? Last week’s price action showed the shortcomings of not making official statements, as both sides will anonymously brief their own preferred media, causing volatility in markets.
  • Finally, the EU has been clear in indicating that honoring the Northern Ireland provisions of last year’s withdrawal agreement are a prerequisite of any trade deal. Uncertainty remains over what this means for ongoing negotiations, however. A successful trade deal may render the protocol redundant by providing a means for border-free trade on the island of Ireland, so the question is if Boris Johnson’s refusal to amend the legislation will in itself be a threat to signing a deal.

 

Authors: 
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, FX Market Analyst

 

 

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