Sentiment is Fickle

Sentiment is a fickle lover.  It blows hot and cold quickly, though not entirely without reason.  For traders, it is often the deus ex machina. Sentiment had swung so hard against the dollar that astute observers and the leading financial press warn that its role in the world economy was in jeopardy.

The greenback recovered from the initial slide on the Federal Reserve's confirmation that it was adopting an average inflation target.  Those upticks were cited by some pundits as evidence that announcement was well-tipped (sell the rumor, buy fact) and that the dollar's bad news has been discounted in the move lower since the end of March.  

However, European and Asian participants took advantage of the North American price action to sell the dollar.  New lows for the year were recorded against sterling and the Australian dollar ahead of the weekend.  The euro, which is where the speculative interest has been the strongest, continues to struggle to sustain gains above the $1.19 level. That is the upper end of a two-cent range that has mostly confined the price action this month and it closed barely above there before the weekend.   The jump in US bond yields helped lift the dollar to the upper end of the month's range (~JPY107) before sentiment swung against it again. Prime Minister Abe's resignation (that had been rumored but we did not believe it) raised issues about the trajectory of policy.  The dollar fell hard toward the lower end of the month's range (~JPY105) before stabilizing.   Of the majors, sterling, the Australian dollar, and Canadian dollar appear to have broken out of their previous ranges.

While the market continues to ruminate over the significance of the Fed's greater tolerance for inflation, the sustainability of the back up in yields, and the policy significance of the end of the Abe government in Japan, the economic calendar picks up.  Besides not raising interest rates simply because the 2% target is approached, it is not clear what the Fed will do to ensure that the target is indeed approached in the first place.  Given the state of the Japanese economy (likely experiencing its first quarterly expansion in four) and the disinflationary pressure (if not deflation as Tokyo's August CPI hinted) it is difficult to see a dramatic change from Abenomics, which seemed to be the traditional LDP policy mix of expansionary monetary and fiscal policy while taxing consumption. 

Although the NY and Philadelphia Fed manufacturing surveys disappointed, other economic data have mostly surprised on the upside.  Admittedly weekly jobless claims, and especially, continuing claims also disappointed.  Still, on balance, the high-frequency US data has held up better than feared.  The durable goods orders and the stronger than expected rise in personal consumption expenditures (1.6% in July vs. median forecast of 1.3% in the Bloomberg survey and an upward revision in June from 5.2% to 5.7%)  coupled with stronger than expected July consumption figures will prompt upward revisions to growth forecasts.

The preliminary PMIs are typically so accurate that revisions in the final tend to be minor.  The ISM is likely to confirm that the US manufacturing sector is snapping back.  The key here is the auto sector.  In the July durable goods orders report on August 26, orders from motor vehicles and parts industry jumped almost 22% after an 85.6% surge in June.  In contrast, orders for aircraft and parts continued to decline.  Boeing had no new orders in July and only one in June.

Manufacturing vehicles is one thing, and purchasing them is another.  At a 14.52 mln seasonally adjusted annual rate in July, it was about 14% below sales figures in July 2019.  August auto sales figures are not expected to change from July according to the Bloomberg survey, but we suspect there is scope for an upside surprise.  That said, supply considerations (low inventories of several brands, including Toyota, Lexus, and BMW, according to industry reports.   High levels of unemployment, the loss of $600 a week in federal unemployment insurance, and heightened uncertainty appear to be constraints on demand.

The US employment data, however, is the highlight of the week.  Recall that the US nonfarm payrolls collapsed by 22.1 mln in March and April.  In the three months through July, about 9.28 mln workers returned or about 42%.  The median forecast in the Bloomberg survey is for another 1.575 mln people returned in August.  The average forecast was about 1.47 mln, and the range was 750k to 2 mln.  With a little bit of luck, the unemployment rate can slip back below 10%, the peak in the Great Financial Crisis.  Some estimate that around a quarter of the overall job loss (~5.5 mln people) may be permanent.  That still leaves scope gradual improvement in the coming months.

The manufacturing jobs filled in July (26k) were a tenth of what economists had expected.  Around 1.35 mln manufacturing jobs were lost in March and April, and in the following three months, a little more than half (52%) or 723k workers returned.  Economists reined in their forecasts for manufacturing jobs in August, but the median projection is for a robust 88k increase.  

Two other sectors will attract interest.  First is employment in the leisure and hospitality industry.  In July, its 592k increase was about a third of the overall rise in nonfarm payrolls.  Bars and restaurants accounted for the lion's share after growing 2.9 mln in the previous two months. Employment is still about 2.6 mln below February levels.  Ths second is government employment, which rose by 301k in July and is expected to increase by around 200k in August.  Seasonal adjustments in this unique year were a source of distortion as the loss of public sector teachers took place earlier.  The federal government hired 27k people in July for temporary jobs related to the census.  

Canada also reports its July employment data on September 4.  It has done a better job of bringing employees back than the US and appears to have been more cautious about relaxing social distancing protocols.  After losing 3 mln jobs in March and April, it has seen 1.66 mln return or 55%.  On the other hand, of the 1.95 mln, full-time positions that were lost, only 40% have returned (~781k).  

In addition to the final PMI readings, the eurozone regales the market with the July retail sales and the first look at August CPI.  Retail sales were hammered in March and April, dropping 10.4% and 12.1%, respectively, before staging a "V" recovery gaining 20.3% in May and 5.7% in June.  In June, eurozone retail sales were 1.3% above year-ago levels.  The pace of recovery is likely to have slowed further in July to a still strong 1.7%.  That would lift the year-over-year rate to 3.7%, the largest increase since November 2017.   July US retail sales were 2.7% year-over-year.

Like other high-income countries, despite the low yields and rapid money supply growth (M3 rose 10.2% year-over-year in July, its fastest pace since May 2008), the eurozone is hampered by low inflation.  The headline pace may be halved from the 0.4% year-over-year increase reported in July, and the core may have slipped back to 0.8% from 1.2%.  The core averaged 1.0% in each of the past three years, so the change in the core is relatively modest. The euro is hardly a significant culprit. It has risen about 5.4% against the dollar this year and about 3.5% on a trade-weighted basis.  The OECD's PPP model sees the euro as almost 20% under-valued.  

Two central banks meet next week, and both are interesting in their own rights.   Both the Reserve Bank of Australia and Chile meet on September 1.  The RBA has kept its cash target at 25 bp and has targeted the 3-year yield also at 25 bp.  Although the yield control seemed to require little central bank action, it chose last month to boost its bond-buying as the spreading virus threatened the recovery. In testimony to Parliament, Governor Lowe acknowledged that although he would prefer a weaker currency, it was broadly in line with fundamentals.  The OECD's purchasing power parity model puts fair value near $0.6900.  Lowe played down the benefit of negative interest rates and expressed confidence that the cash rate would remain where it was for the next three years.   The Australian dollar is up about 1.2% in August against the US dollar and near its best levels since early 2019. 

Chile has among the lowest real policy rates in the world.  Its overnight cash target was hiked by 25 bp to 3.0% in January 2019, which completed a two-hike 50 bp tightening cycle.  It unwound the hikes last June, cut another 50 bp in September, and  25 bp in October to finish the year at 1.75%.  The Chilean economy contracted by 4.1% quarter-over-quarter in Q4 19.  When the virus struck in March, the central bank slashed the cash target to 50 bp, where it has remained.  Meanwhile, the CPI peaked near 4% in February and stood at 2.5% in July.  The central bank has a 2%-4% inflation target.  Ironically, the Chilean peso is the best performing of the major Latin American currencies, off about 4.3% against the dollar. 

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