This is likely to be one of the most important US data months we’ve had in a while. While we have gotten some glimpses of June data already, this week brings the first major reads on the US economy. Over the next couple of weeks, we will even start to see some early July data trickle out, which is arguably even more important now that some states have had to slow or even reverse some reopening steps.
We are concerned that that the US economy may start taking a step back just as Q3 is about to get under way given rising infection numbers in several states. Data has come in overwhelmingly positive over the last several weeks, as reflected by the sharp increase in aggregate measures of economic surprise. We fear that this marked improvement led investors to price risky assets to a smooth flattening of the virus curve in the US, as seen in many European and Asian countries. But this assumption is now being challenged.
Rising virus numbers have forced Texas and Florida to close down bars again after allowing them to reopen. Problems in those states that reopened early are serving as a cautionary tale, as New Jersey is pausing its plan to restart limited indoor dining. New York is poised to follow suit. The states that are experiencing higher virus numbers are a significant part of the US economy. California accounts for nearly 15% of GDP, followed by Texas at nearly 9%. Florida accounts for 5% of GDP so those three states together account for almost 30% of total US GDP. With many reopenings on hold now, this will be a headwind that carries over into Q3. If these states can quickly bend the curve back down, perhaps the recovery can proceed but as of now, we are getting more pessimistic about the US economy.
Our broad macro calls will be tested over the next few weeks as the US reports some key data (see below). Faithful readers will know that we have been bearish on the dollar near-term due to the Fed’s extremely aggressive policy response to the pandemic. Balance sheet expansion and money growth are much faster here than in the eurozone and Japan, which has kept the dollar under pressure more or less since March. For more details, please see Our Latest Thoughts on the Dollar.
Looking further out, we had been more constructive on the dollar. As we saw during the financial crisis, the Fed was similarly aggressive, and the dollar came under pressure in the initial stages of QE. Once other central banks played catchup, the dollar recovered, especially as the US economy responded to the stimulus. This dynamic may or may not play out again this time. Given the worsening virus numbers in the US, we believe that the rest of the world is now likely to outperform the US in Q3 and perhaps even Q4.
In June, stronger than expected US data helped feed the reflation trade. The 3-month to 10-year US curve steepened to 75 bp in early June. This was the steepest it had been since late March and was part of the widespread reflation trade. Now, recent developments have pushed the long end lower so that the curve is now only around 50 bp steep. Likewise, strong data pushed the S&P 500 higher to a cycle peak near 3233 June 8. Stocks are off those highs are awaiting more signals from the US economy.
Until we get confirmation that the US is facing prolonged recession risk, we are sticking with our broad macro calls for Q3. These include a softer dollar, higher equities, and a bearish steepening of bond yields as the economy picks up further. These calls were coming to fruition as the US data surprised to the upside in May and June. However, the renewed virus threat points to a potential reset across all markets. Our calls hinge critically on our view that the US economy emerges from recession quickly due to the aggressive stimulus (monetary and fiscal) in the pipeline. These calls will be tested time and again and we expect heightened volatility across all markets to continue in the coming months.
The data remain key. If the virus numbers worsen, then the growth outlook changes and the economy faces a more prolonged recession and recovery, then the US will lag many other nations. The Fed will have no choice but to remain lower for longer, and we would have to revisit our medium-term bullish dollar call.
If renewed lockdowns (whether official policy or self-imposed) intensify in Q3, that is an argument for protracted dollar weakness. While we have long felt that the US economy was poised to outperform coming out of this crisis, recent developments call this into question. The eurozone and Japan have keep the curve low. Even the UK has managed to push its curve down. It’s still early yet but investors must prepare for a possibly significant shift in relative growth rates across the globe.
The graphs below focus on absolute levels of activity rather than changes. This is done to underscore just how deep the downturn has been. A 2.5 mln gain in jobs sounds great but looks pretty miniscule next to the -20.7 mln loss the previous month. Likewise, a 17.7% m/m rise in retail sales does not come anywhere close to recouping the losses seen in the previous two months. Simply put, it will take a long time before we get back to pre-pandemic levels of jobs, consumption, and GDP.
June jobs data will be reported Thursday due to the long holiday weekend in the US. Consensus sees a gain of 3.074 mln jobs in June, up from 2.509 mln in May. Unemployment is expected to fall to 12.4% from 13.3% in May, but the data have been rife with errors the past two months. Ahead of the data, ADP will release its reading of private sector jobs Wednesday, with consensus at 2.95 mln currently. Note that last week’s continuing claims for the June survey week fell -767k. Compare this to May, when continuing clams for the survey week fell -4.1 mln and May NFPs came in at +2.5 bln. This latest reading of -767k suggests market consensus of +3 mln is way too optimistic.
Weekly jobless claims will be reported Thursday. Initial claims are expected at 1.35 mln vs. 1.48 mln last week, while continuing claims are expected at 19.0 mln vs. 19.522 mln last week. The fact that initial claims are still hovering close to 1.5 mln suggests the labor market is still under some stress. Indeed, taken at face value, the movement in both claims series would suggest that workers are still becoming unemployed and are eating into the numbers of those becoming employed again.
Important June manufacturing data will come out throughout this week. Dallas Fed survey out Monday came in at -6.1 vs. -21.4 expected and -49.2 in May. The regional Fed surveys all came in better than expected for June, with the Philly Fed even posting a positive reading of 27.5. June Chicago PMI will be reported today and is expected to come in at 45.0 vs. 32.3 in May. This will be followed by ISM manufacturing PMI Wednesday, which is expected at 49.7 vs. 43.1 in May. The employment component will be closely watched for the final clue to Thursday’s jobs data. Final Markit manufacturing PMI will also be reported Wednesday.
ISM non-manufacturing PMI will be reported next Monday July 6. It is expected to improve to 49.1 from 45.4 in May. Given that services account for nearly 70% of the US economy, this is arguably more important than the manufacturing (around 11% of GDP) reading. Markit’s final services and composite PMI readings will also be reported July 6. The preliminary readings stood at 46.7 and 46.8, respectively.
We get our first glimpse of July data with the Empire manufacturing survey July 15. June IP will also be reported that day. The regional Fed surveys continue with the Philly Fed survey out a day later. The Kansas City Fed reports July 23 followed by the Dallas Fed July 27 and the Richmond Fed July 28. It will be interesting to see if the strong June readings can be repeated in July as some states slow or reverse reopening.
June retail sales will be reported July 16. Ahead of that, June auto sales data out this Wednesday will give us an early window into retail sales. Auto sales are expected to come in at an annualized 13.0 mln pace vs. 12.21 mln in May, which represents a nice recovery from the April low of 8.58 mln but still well below the February pre-pandemic rate of 16.83 mln. Johnson Redbook data suggest sales were improving modestly in June, but that improvement is at risk as July gets under way.
Next FOMC meeting is July 28-29. Not surprisingly, recent virus numbers have reinforced Powell’s ultra-dovish message. That is, “we’re not even thinking about thinking about hiking rates.” The Fed is likely to acknowledge some improvement seen but also likely to stress the downside risks emanating from the worsening virus numbers. Indeed, Fed Chair Powell today warned of extraordinary uncertainty ahead. He stressed that “A full recovery is unlikely until people are confident that it is safe to re-engage in a broad range of activities.” Powell also said “We have entered an important new phase and have done so sooner than expected. While this bounce back in economic activity is welcome, it also presents new challenges — notably, the need to keep the virus in check.”
The US economic outlook remains fluid. The Atlanta Fed’s GDPNow model estimates Q2 GDP at -39.5% SAAR, while the NY Fed’s Nowcast model has Q2 at -16.33% SAAR and Q3 at +1.49% SAAR. The Atlanta Fed is likely overstating Q2 contraction and the NY Fed understating it, and we suspect the truth is somewhere in between. Note that Bloomberg consensus sees -34.5% SAAR in Q2, +20.0% SAAR in Q3, and +7.8% in Q4. The latest revision for Q1 last week was unchanged at -5.0% SAAR. The chart below shows the implied path for GDP through Q4 using Bloomberg consensus forecasts. Again, this shows just how far the economy has go to recoup lost output.