Drivers for the Week Ahead

  • The next US recession is a possible game-changer for the dollar; US rates markets are getting even more pessimistic about the US outlook
  • The main event this week in terms of data will be US jobs report Friday; the Fed releases its Beige Book report Wednesday
  • China confirmed it will establish a list of “unreliable” foreign entities that damage its domestic firms
  • Final eurozone manufacturing PMIs will be reported Monday; ECB then meets Thursday
  • RBA meets Tuesday and is expected to cut rates 25 bp to 1.25%; Canada has a heavy data week
  • In EM, the central banks of India, Poland, and Chile meet

We have consistently warned that the next US recession is a possible game-changer for the dollar. When (not if) that hits, the Fed will cut rates and the budget deficit will blow out, which is a recipe for potential dollar weakness. But we’re not there yet. The yellow lights are blinking but recession is not yet our base case scenario. It’s too early to call an end to the dollar rally and so for now, we remain dollar bulls.

US rates markets are getting even more pessimistic about the US outlook. The 3-month to 10-year curve continues to invert. At -20 bp, it is the most inverted in this cycle. Elsewhere, the Fed Funds futures strip is leaning even more dovish. The implied yield on the January 2020 contract is 1.82%, which is fully pricing in two cuts this year and working on a third. Furthermore, the implied yield on the January 2021 contract is 1.46%, which is almost fully pricing in two cuts next year. WIRP sees a 17% chance for a cut at the June 19 FOMC meeting, up from around 5% last week.

The main event this week in terms of data will be US jobs report Friday. Consensus sees 180k jobs added vs. 263k in April. Unemployment is expected to remain steady at 3.6%, as are hourly average earnings growth at 3.2% y/y. While we expect continued firmness in the labor market, it is a lagging economic indicator.

Markets are better off looking at leading and coincident indicators. In that regard, Chicago PMI Friday came in better than expected at 54.2, with new orders and prices paid improving from April. Financial conditions are looser now than when the Fed started the tightening cycle in December 2015. The Chicago Fed National Activity index 3-month average was -0.32 in April, the low for the cycle but well above recessionary levels.

Ahead of the jobs report, the US will report a slew of data. May ISM manufacturing PMI (53.0 expected), vehicle sales (16.83 mln annualized rate expected), and April construction spending (0.4% m/m expected) will be reported Monday.   April factory orders will be reported Tuesday (-0.9% m/m expected), followed by May ADP (183k expected) and ISM non-manufacturing PMI (55.5 expected) Wednesday. May Challenger job cuts, weekly jobless claims (215k expected), and April trade will be reported Thursday.

The Atlanta Fed’s GDPNow model is now tracking 1.2% SAAR for Q2, down from 1.3% previously. Elsewhere, the New York Fed’s Nowcast model is tracking 1.5% SAAR for Q2 vs. 1.4% the previous week. Q2 data have been on the soft side, but we note that Q1 also started off on a soft note before rebounding to 3.2% SAAR growth in the advance report. While a slowdown from Q1 was expected, markets will be particularly sensitive for a larger than expected drop-off.

The Fed releases its Beige Book report Wednesday. This is also the last week of Fed speakers ahead of the media embargo for the June 19 FOMC meeting. Daly speaks Monday in Asia, followed by Barkin and Bullard in the US later that day. Williams, Powell, and Brainard speak Tuesday, followed by Clarida, Bowman, and Bostic Wednesday. Kaplan and Williams speak Thursday, followed by Daly again in Asia Friday. If markets remain in turmoil, Fed messaging this week will take on even greater significance.

Obviously, the big question is whether the Fed will cave in to the market again. As we’ve said before, a lot of the current turmoil is man-made (in terms of tariffs) by the White House. Should the Fed bail out the government from its own policy mistakes by cutting rates? If we go into recession, yes. But cutting rates to offset the tariff impact is a second-best policy. What’s the first-best? Get rid of the tariffs.

China confirmed it will establish a list of “unreliable” foreign entities that damage its domestic firms. The first batch of targeted names will be released soon. FedEx has already been singled out for investigation for “wrongful delivery of packages” sent to Huawei. With both sides digging in, things are going to get worse before they get better.

Over the weekend, Korea reported May exports at -9.4% y/y. This was worse than expected and the sixth straight month of contraction. Semiconductor exports fell a whopping -30.5% y/y, leading Samsung to convene a weekend meeting to discuss ways of dealing with deteriorating outlook. Korea is just one of many nations to feel the negative spillover from US-China trade tensions.

Mexico has yet to announce any retaliatory measures, as AMLO takes a more conciliatory approach. However, we think it is only a matter of time before domestic pressures force AMLO to retaliate. Before the tariff news, Banco de Mexico had cut its growth forecast for this year to 0.8-1.8%. Now, the odds of recession there have risen sharply even as the weak peso and rising inflation risks force the bank to keep rates high.

Final eurozone manufacturing PMIs will be reported Monday. Flash reading was 47.7. Final services and composite PMIs will be reported Wednesday. In between, May eurozone inflation will be reported Tuesday, which is expected to ease to 1.3% y/y vs. 1.7% in April. However, considering the lower than expected inflation reported by France and Germany last week, we see downside risks for the eurozone reading.

ECB then meets Thursday and is expected to keep rates steady. More details of the planned TLTRO should be forthcoming, with many looking for a negative interest rate. Updated staff forecasts will be released. We think it will have to acknowledge downside risks to the economy with downward revisions to the growth and inflation outlook. Lower oil prices are likely to keep downward pressure on inflation readings worldwide.

UK PMI reports for May come out this week. Manufacturing (52.2 expected) is first up on Monday, followed by construction (50.6 expected) Tuesday and services and composite (50.6 and 51.0 expected, respectively) Wednesday. Bank of England next meets June 20 and it is not doing anything until Brexit planned for October 31. Indeed, implied yields on short sterling contracts show the next hike priced in Q1 2023 and the one after that beyond Q1 2025.

In the UK, Prime Minister May is scheduled to step down this Friday. Ahead of that, she will be in the public eye as she hosts President Trump’s state visit Monday and then takes part in D-Day celebrations Thursday. After she rides off into the sunset, the Tory leadership race comes in focus. Boris Johnson remains the favorite to replace her and markets are digesting rising odds of a hard Brexit.

RBA meets Tuesday and is expected to cut rates 25 bp to 1.25%. Earlier that day, Australia reports Q1 current account data and April retail sales. Q1 GDP will be reported Wednesday, with growth expected to ease to 1.8% y/y from 2.3% in Q4. Downside risks to the economy have markets looking for three potential cuts this year.

Canada has a heavy data week. It reports April trade and May Ivey PMI Thursday. Friday, Canada reports May jobs data. The Bank of Canada just kept rates steady and delivered a less dovish than expected message by saying that the slowdown is seen as temporary. Markets think otherwise, with WIRP showing rising odds of a rate cut in the autumn. Next policy meeting is July 10, no change is expected then.

In EM, the central banks of India, Poland, and Chile meet. Only RBI is expected to move, and it is seen continuing the easing cycle with another 25 bp cut in policy rates. Indeed, more EM central banks are likely to ease in the coming weeks. Russia is expected to ease June 14, while the Philippines is expected to continue easing June 20. Indonesia meets that same day and may follow suit.