Macro as September Winds Down

The dollar began September extending its losses, but reversed higher and is winding down the month at its best levels against the euro and sterling in a couple of months. The Canadian and Australian dollars have approached last month's lows, and even the strong demand for the Mexican peso and Chinese yuan appeared to have dried up.   The quarter-end adjustments are thought to require net dollar buying.  

The apparent contrast between the lack of new monetary and fiscal signals in the US while other major centers are expected to ease policy still this year may have encouraged short-term players and trend followers to cover short dollar exposure.  Indeed, when the weekly initial jobless claims edged higher (second time in three weeks), and Treasury Secretary Mnuchin seemed to emphasize the desire to negotiate new fiscal support, the dollar, which had been well bid,  softened. The resurgence of the virus in Europe and the increased volatility of equities may have also encouraged the position adjusting in the foreign exchange market.   We expect that additional support for the US economy will be forthcoming, but not until after the election, and maybe, not until next year.   The recent market movements may be more about positioning than inherently favorable for the dollar, even if the upside correction continues a little longer.   

As September winds down, it seems clear that the strong momentum that many high-income countries enjoyed at the start of the quarter eased, and this will make Q4 more challenging.  Manufacturing is doing better than services, which continue on the whole to be more hamstrung by the virus.  Attempts to begin returning to work and school have been stymied by new outbreaks.  It is making for an uneven and fragile recovery. 

The week ahead provides several new data points.  There are several top-tier US economic reports, including September jobs and auto sales.  The eurozone reports the preliminary estimate for September inflation, and Japan's Tankan Survey will be released.  Investors can look forward to China's PMI and other countries, of which only have preliminary releases. The UK and the EU enter the home stretch for the trade pact negotiations that ought to be completed before the mid-October EU Summit if countries are to complete the ratification process.   The first US presidential debate will take place on September 29.  It will draw interest, but polls suggest a low percentage of undecided and those that cite the debate as salient for their choice. 

The historic contraction in the US second quarter will be "relived" in the sense that another revision will be made.  China makes one estimate and is done with it. Many are critical of it because it is seen as politicized and not always consistent with other data.   The US, in contrast, makes an estimate and revises it for years, and sometimes the revisions can be statistically significant.  The robustness of the various US estimates lies not in any one's estimate's accuracy but in the objective process of the calculation. 

Economists will use the August personal income and consumption data to polish Q3 GDP forecasts. The report will also drive home the problem of extrapolating from the volatile data.  Personal income is expected to drop sharply after having surged earlier in the crisis.  Consumption jumped nearly 2% in July and likely slowed to a still-strong pace even if below 1%.  Of course, part of the early rise in income was due to government transfers. The loss of the federal unemployment insurance and the expiration of the Payroll Protection Plan contributes to the Q4 fiscal drag that is fueling expectations for a sharp slowdown from what looks like a strong Q3.  The median forecast in the Bloomberg survey envisions a 25% GDP (annualized rate) in Q3.  The median forecast for Q4 is a 5% pace in Q4, which perhaps not surprisingly matches the NY Fed's Nowcast estimate.  At least two large US-headquartered banks cut Q4 forecasts as they gave up on the prospects of fiscal stimulus.

The PCE deflator, for which the Fed's now has a 2% average target, will draw attention.  A 0.3% increase on the month would put the year-over-year rate at 1.2% compared with 1.0% in July. The same monthly increase in the core rate would see the year-over-year pace slow to 1.3% from 1.5%.  Boston Fed President Rosengren opined that "we'd be lucky" to get inflation to 2% in four years. 

The US nonfarm payrolls report is often the most anticipated and market-sensitive economic report. The labor market continues to recover, but the pace has slowed considerably, and the weekly initial jobless claims have risen for two of the past three weeks through September 18.  The median forecast in the Bloomberg survey sees nonfarm payrolls increasing by 850k, after 1.37 mln in August.  The headline August number was flattered by around 340k government (mostly census) workers.  Private sector employment growth is forecast to be about 175k less than in August.  Industrial output and retail sales disappointed in August, and this could point to downside risk with the September employment report.

On the other hand, some employees were being recalled after Labor Day.  The unemployment rate, derived from the household survey, is expected to slip to 8.2%, which was the rate in the summer of 2012 as the recovery from the Great Financial Crisis was taking hold.  It has been in a range this year of 3.5% in February to 14.7% in April.  Although the data will impact Q3 GDP forecasts, it will have little impact on monetary or fiscal policy.  The Fed has no intention of lifting rates until inflation is above 2%, and the obstacle to fiscal stimulus is political will not economic need.

Manufacturing, and the auto sector, in particular, have helped fuel the recovery in the industrial sector.  Auto sales are gradually recovering and are likely to have increased for the fifth consecutive month in September.  Here too, though, the monthly increase may be slowing.  A nearly 15.6 mln unit seasonally adjusted annual pace is expected at 15.2 mln in August.  The average this year has been almost 13.6 mln compared with 16.9 mln in the first eight months of last year.  A wider range of high-frequency economic reports has shown a loss of momentum.  

II

The eurozone is awash in liquidity, and this has helped drive the three-month Euribor a little below the ECB's deposit rate of minus 50 bp, which theoretically is the floor for rates.  Despite this, banks took another 175 bln euros in loans with rates that could easily be as low as minus 100 bp on top of the 1.3 trillion euros taken in the previous operation at the end of Q2.  Over the past ten weeks, the ECB's balance sheet has been expanding by slightly less than 20 bln euros on average.  Many expect the ECB to extend its Pandemic Emergency Purchase Program in December. Still, recent comments suggest the possibility of another rate cut, as the dual-rate appears to have created new possibilities.  

The preliminary estimate September CPI will be released on September 30.  The August report showed the first negative reading (-0.2%) four years, and the deflation risk may have contributed to the focus in some quarters on the euro's strength.   Yet, most would agree that the August CPI overstated conditions.  The cut in the German VAT, changing seasonal sales promotions and sales, and discounts for tourism and travel services depressed the metric.  The point is that the noise-to-signal ratio was strikingly high.  

The monthly headline rate fell 0.4% in July and another 0.4% in August.  It likely stabilized in September.  Due to the base effect (rose 0.2% in September 2019), it must rise by around 0.4% to return the year-over-year rate to zero.  The median forecast in the Bloomberg survey is for a 0.3% month-over-month increase that leaves the year-over-year rate unchanged at -0.2%.  The core rate is expected to be unchanged at the record low 0.4% seen in August.  We suspect that deflation is mostly driven by transitory factors, but low inflation remains a chronic condition (of course, not in only Europe).  

The UK-EU formal trade talks resume September 28, and time is of the essence.  The strains are threatening to boil over, increasing recognition of the potential for significant disruption.  The controversial Internal Market bill that overturns part of the Withdrawal Agreement will be voted on again in the coming week.  The compromise forged that requires Parliament approval to trigger the most egregious measures ensures that it will be approved in next week's final vote before heading to the House of Lords.  The upper chamber can attach amendments and delay the process.  Meanwhile, the EC has threatened to take legal action if the measure is not withdrawn by the end of the month.  

Even pre-Covid, many observers expressed concern that the UK would not be ready to exit the standstill agreement at the end of the year, without significant disruptions and delays.  Recent reports underscore this observation.  Many UK truckers may not be prepared with proper paperwork and border controls.  Consider that, according to some accounts, a typical UK truck of groceries would need over 400 separate certificates to enter Northern Ireland.  Facilities (e.g., sanitary and phytosanitary) in Britain that would check goods coming from Northern Ireland (and the EU) are not going to be ready, according to senior UK officials cited. Specific definitions and regulations have not been agreed between the UK and the EU. The resurgence of the virus and new social distancing measures pose new obstacles.  

Japan's new prime minister begins as the economy appears to be growing by around 15.5% (annualized) in Q3, the first quarterly expansion since before the sales tax increase last October.  The Suga government upgraded its economic assessment of output, exports, and employment while keeping the overall view unchanged.  This week's release of the Tankan Survey will likely shed light on why the PMI remains below 50 if things are improving.  The results are broken down not just in terms of activity (manufacturing and non-) but also in size.  Japanese companies were hit hard, but the recovery for large businesses seem stronger, and the Tankan Survey will likely bear this out.  

The BOJ is looking through the drop in the core inflation rate (excludes fresh food) to -0.4% in September, the most deflationary reading in four years.  It suffered some of the same transitory distortions as Europe did, but also, the Japanese government offered discounts for tourism and travel.  Monetary policy was a main "arrow" of Abenomics and seems nearly naturally transferable to the Prime Minister Suga.  Governor Kuroda has not committed to anything but extending the emergency lending programs set to expire at the end of March 2021.  

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