Drivers for the Week Ahead

  • So far, the US yield curve inversion has not stuck; yet markets are still pricing in Fed rate cuts this year
  • Our strong dollar call will be tested this week with another big data dump for the US
  • Of course, the highlight will be the jobs data Friday
  • The Brexit outlook remains as clear as mud; UK reports its March PMI readings this week
  • Japan Tankan report for Q1 and final March manufacturing PMI were released earlier today
  • RBA meets Tuesday and is expected to keep rates steady at 1.5%; Canada also reports March jobs data Friday
  • In EM, the central banks of Poland and India meet; South Africa and Turkey remain in focus

The dollar is mostly weaker against the majors as the new quarter begins with a dose of risk-on sentiment.  Sterling and Nokkie are outperforming, while the yen and Loonie are underperforming.  EM currencies are mostly firmer.  ZAR and MXN are outperforming, while PHP and TRY are underperforming.  MSCI Asia Pacific was up 1%, with the Nikkei rising 1.4%.  MSCI EM is up 0.8% so far today, with the Shanghai Composite rising 2.6%.  Euro Stoxx 600 is up 0.8% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 4 bp at 2.44%, while the 3-month to 10-year spread is up 3 bp to stand at 6 bp.  Commodity prices are mostly higher, with Brent oil up 1.2%, copper up 0.5%, and gold down 0.2%.

The dollar was truly mixed in Q1 against both the majors and EM.  In the majors, sterling (+2.2%) and Loonie (+2.2%) outperformed while Stockie (-4.7%) and the euro (-2.2%) underperformed.  In EM, RUB (+6.2%) and THB (+2.6%) outperformed while ARS (-13%) and TRY (-5.1%) underperformed.  What does Q2 hold in store for investors?

We are putting the finishing touches on our FX quarterly, which sees Q2 shaping up as a “wait and see” quarter.  Will the US economy recover from Q1 softness?  Will the US yield curve inversion be sustained?  Will the economies of China and eurozone stabilize?  What happens with Brexit? Or the US-China trade war?   We expect heightened volatility in Q2 as markets struggle with these and other questions.  However, we are sticking by our strong dollar call this quarter.

So far, the US yield curve inversion has not stuck.  Nor should it.  Equity markets are not pricing in a recession even as the bond markets suggests heightened risks.  Which market is right?  Only time will tell but we side with equities as we simply do not see a recession this year.  The labor market remains near full employment, which should continue to support consumption.

Yet markets are still pricing in Fed rate cuts this year.  The Fed Funds futures strip shows a rate cut fully priced in by January 2020 and another cut fully priced in by December 2020.  No one really expects a move at the May 1 FOMC meeting.  However, Bloomberg’s WIRP model suggests a nearly 20% chance of a cut at the June 19 meeting.  This seems to overstate the case.

Our strong dollar call will be tested this week with another big data dump for the US.  US reports February retail sales and March ISM manufacturing PMI Monday and will be bookended by March jobs data Friday.  Both headline and ex-auto sales are expected to rise 0.3% m/m.  So too is the so-called control group that is used to calculate GDP.  ISM PMI is expected to rise to 54.5 from 54.2 in February.

Of course, the highlight will be the jobs data Friday.  Consensus sees 175k jobs added vs. 20k in February.  Note that as of February, the 3-month average was 186k, the 6-monht was 190k, and the 12-month was 209k.  Unemployment is seen steady at 3.8%, while average hourly earnings are seen staying at the cycle high of 3.4% y/y.  JOLTS data continue to show a tight labor market.  Can higher wages be far behind?

In between, a lot of other data will be reported.  February durable goods orders (-1.8% m/m expected) and March auto sales (16.7 mln annualized rate expected) will be reported Tuesday, followed by March ADP private sector jobs (175k expected) Wednesday.  ISM non-manufacturing PMI will also be reported Wednesday (58.0 expected).

There are several Fed speakers this week.  Bostic (non-voter), George (voter), Barkin (non-voter), and Kashkari (non-voter) all speak Wednesday.  Mester and Harker (both non-voters) speak Thursday, while Bostic speaks again Friday.  Last week, both Williams (voter) and Bullard (voter) played down the risks of recession and rate cuts.  We tend to agree with them and we also believe that they represent the Fed consensus that is currently in place.  The bar to a rate cut remains high, at least for now.

The Atlanta Fed’s GDPNow model is now tracking 1.7% SAAR, up from 1.5% previously.  Elsewhere, the New York Fed’s Nowcast model is tracking 1.3% SAAR for Q1 and 1.6% for Q2.  Final US Q4 growth was just revised down to 2.2% SAAR from 2.6% previously, and so it appears that growth is still slowing sequentially from the 4.2% peak in Q2 2018.  However, this isn’t exactly pointing to recession this year.

Eurozone reported final manufacturing PMI readings earlier today.  Headline PMI fell a tick from the flash reading to 47.5.  Germany was the biggest drag, falling to 44.1 from 44.7 flash, while France fell a tick to 49.7.  Italy was reported at 47.4, down from 47.7 in February, while Spain improved to 50.9 from 49.9 in February.  Final services and composite PMI readings will be reported Wednesday.

The Brexit outlook remains as clear as mud.  Last week, several votes in Parliament confirmed what most already knew:  that there is no clear agreement on how to move forward.  No majority could be mustered for all eight alternatives.  The two that received the most support were a customs union with the EU and a second referendum.  Parliament is expected to hold another round of votes this week, but it seems that markets are still betting on a lengthy delay to Brexit.

UK reports its March PMI readings this week.  Manufacturing was reported earlier today at 55.1 vs. 51.2 expected and a revised 52.1 (was 52.0) in February.  Construction PMI is out Tuesday (49.8 expected) and services and composite readings out Wednesday (50.9 and 51.0 expected, respectively).  With Brexit uncertainty ongoing, this leaves the BOE no choice but to wait and see.  Next policy meeting is May 2 and no change is expected then.

Bank of Japan’s Tankan report for Q1 was released earlier today and most readings were weaker than expected.  The large manufacturing index fell to 12 from 19 in Q4, while the large manufacturing outlook fell to 8 from 15 in Q4.  The small manufacturing index fared even worse, with the headline falling to 6 from 14 in Q4 and the outlook falling to -2 from 8 in Q4.  Large all industry capex spending is expected to fall sharply to 1.2% from 14.3% in Q4.

Final Japan March manufacturing PMI was also reported earlier at 49.2 vs. 48.9 preliminary.  Services and composite PMI will be reported Wednesday, while February household spending and labor cash earnings will be reported Friday.  Next Bank of Japan meeting is April 25 and it is expected to reaffirm its commitment to maintain loose policy until the 2% inflation target is met (whenever that may be).

Reserve Bank of Australia meets Tuesday and is expected to keep rates steady at 1.5%.  February retail sales (0.3% m/m expected) and trade (AUD3.7 bln surplus expected) will be reported Wednesday.  There is no doubt that the Australian economy is facing serious headwinds.  However, we think some market calls for two rate cuts this year overstates the dovish case.

Canada also reports March jobs data Friday.  Consensus sees a -10k net loss in jobs, which should be payback for the incredibly strong 55.9k gain in February that was driven largely by full-time work (up 67.4k).  Ahead of that, it reports March Markit PMI Monday and Ivey PMI Thursday.  Next Bank of Canada meeting is April 24.

China PMI readings for March came in stronger than expected over the weekend.  Caixin’s manufacturing PMI rose to 50.8 from 49.9 in February, while the official manufacturing PMI came in at 50.5 vs. 49.2 in February.  These readings could allay some fears about global growth, though this may be offset by signs that the US-China trade deal will take longer than expected to complete.  Vice Premier Liu will arrive in Washington for talks that resume Wednesday.

In EM, National Bank of Poland and Reserve Bank of India meet this week.  The former is expected to keep rates steady, but the latter is widely expected to deliver its second straight rate cut.  Price pressures remain low and so added stimulus would be welcome news for the Modi government ahead of elections that begin this month and run into May.

It appears South Africa got a reprieve from Moody’s.  The agency was scheduled to release its report late Friday, but nothing was issued nor explained.  We believe a downgrade to Ba1 is warranted and so we do not think South Africa is out of the woods yet.  Elsewhere, local elections in Turkey saw Erdogan’s AKP lose the mayoral races in Ankara and Istanbul.  Now that the vote is complete, we suspect the lira will come back under severe pressure.