Drivers for the Week Ahead

  • It turns out that Powell’s Jackson Hole speech was one of the least important developments last Friday
  • Recession fears spiked again after China announced retaliatory tariffs on $75 bln of US goods; Trump “hereby ordered” US companies to leave China and also hiked tariffs again
  • The US economy remains in solid shape, at least for now; we must acknowledge that the risk of recession has risen sharply
  • Trump said that a US-Japan trade deal has been agreed to in principle; Abe demurred
  • In EM, the central banks of Hungary, Israel, and Korea meet; China reports official August PMI readings Saturday

It turns out that Powell’s Jackson Hole speech was one of the least important developments last Friday.  Still, his thoughts bear repeating.  Powell pledged to act “as appropriate” to sustain the expansion, adding that the economy is in a favorable place even as its faces “significant” risks.  Overall, Powell took a balanced tone that didn’t promise a cut in September.  That’s what we expected but some may be disappointed in his less dovish than desired stance.  The only Fed speakers this week are Barkin and Daly, both on Wednesday.

Recession fears have spiked again after China announced retaliatory tariffs on $75 bln of US goods Friday.  The targeted goods were soybeans, oil, and autos, which happen to be produced largely in the so-called Red States.  This is a strong statement by China as the timing came just ahead of Powell’s speech and the weekend G-7 summit in France.  Editorial and official comments suggest that China is hunkering down for the long haul.

President Trump “hereby ordered” US companies to leave China.  Trump, Mnuchin, and Kudlow all claimed that Trump as the ability to do this under the so-called International Emergency Economic Powers Act.  Whilst meant to deal with rogue nations, the IEEPA has never been used to punish a major trading partner.  All three said there were no plans to use it now.

President Trump said at the G-7 summit that he has some regrets about the trade war.  The White House later clarified that the only regret he has is not raising tariffs on China even more.  This came after he announced five percentage point increases in both current and planned tariffs on China.

Powell directly addressed trade tensions in his speech: “There are, however, no recent precedents to guide any policy response to the current situation. Moreover, while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rulebook for international trade.”  Well said.

USD JPY, and JPY should remain bid in this environment.  It will come at the expense of growth-sensitive currencies like the dollar bloc, Scandies, and EM.  Quite simply put, President Trump’s moves to intensify the trade war will likely have the perverse effect of boosting the dollar against most currencies.  Jawboning is likely to continue but we downplay the near-term risks of unilateral FX intervention by the US.

We believe the Chicago Fed National Activity Index remains the best indicator to gauge US recession risks.  The 3-month average was -0.26 in June, the best since February and well above the recessionary threshold of -0.70.  The July reading will be reported Monday and is expected at 0.05.  If so, it would be the first positive reading since November and would take the 3-month average to 0.00, the best since January.  Note that a value of zero shows an economy growing at trend.  Positive values represent above trend growth, while negative values represent below trend growth.  July durable goods orders will also be reported Monday and are expected to rise 1.0% m/m.

Regional Fed manufacturing surveys for August will continue to roll out this week.  Dallas reports Monday and is expected at -4.5 vs. -6.3 in July.  Richmond reports Tuesday and is expected at -4 vs. -12 in July.  These will lead right into Chicago PMI Friday, which is expected at 47.9 vs. 44.4 in July.  Other data Friday include personal income and spending, core PCE, and final August Michigan sentiment.

The US economy remains in solid shape, at least for now.  The Atlanta Fed’s GDPNow model is tracking 2.2% SAAR growth in Q3.  This is above trend (~2%) and little changed from the preliminary 2.1% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 1.8% SAAR growth in Q3.  Another revision to Q2 GDP will be seen Thursday, with growth expected at 2.0% SAAR vs. 2.1% previously.  July goods trade data and retail/wholesale inventories will also be reported Thursday.

Yet we must acknowledge that as the US-China trade war extends and expands, the risk of recession has risen sharply.  The US 3-month to 10-year yield curve has inverted further to -46 bp, the low for this cycle.  WIRP suggests 100% odds of a rate cut September 18, while the odds of a 50 bp move have jumped to 30% from basically zero last Thursday.  Elsewhere, the implied yield on the January 2020 Fed Funds futures contract fell to 1.43%, which means 75 bp of easing before year-end is almost fully priced in.  This is followed by another 50 bp of easing priced in for 2020.

Germany reports August CPI and unemployment Thursday.  Inflation is expected to fall to 1.5% y/y from 1.7% in July.  Germany reports July retail sales Friday, which is expected to fall -1.4% m/m.  Eurozone reports August CPI Friday, which is expected to fall a tick to 1.0% y/y.  Ahead of that, July IFO business climate Monday and August GfK consumer confidence Wednesday are expected to worsen.  All signs point to ECB easing September 12, though WIRP suggests only 79% odds of a cut.

There are no major UK data releases this week.  Rather, all eyes will be on the ongoing Brexit saga.  Boris Johnson’s trip last week to France and Germany yielded nothing but vague willingness to find common ground, and the Irish backstop remains a deal-breaker for both sides.  BOE Governor Carney finally admitted at Jackson Hole that it would more likely ease than not if there were a hard Brexit.  That is the common sense response, in our view.

Japan reports a huge raft of data Friday.  These include August Tokyo CPI, July unemployment, retail sales, IP, housing starts, and construction orders.  Tokyo headline inflation is expected to fall to 0.6% y/y from 0.9% in July, while ex-fresh food is expected to fall to 0.8% y/y from 0.9% in July.  Retail sales are expected to fall -0.9% m/m and IP is expected to rise 0.3% m/m.

Trump said that a US-Japan trade deal has been agreed to in principle and that Japan would purchase large amounts of US grains.  Prime Minister Abe said more work is needed, adding that US agricultural purchases were possible but to be decided by the private sector.  This was not enough to offset the negative impact coming from US-China tensions.  The yen has been the major beneficiary of the growing risk-off sentiment as USD/JPY fell below the January flash crash low to trade near 104.45.

In EM, the central banks of Hungary, Israel, and Korea meet.  None are expected to change rates, though we see slight risks of a dovish surprise from Bank of Korea.  The deepening trade war is unequivocally negative for EM.  CNY, INR, SGD, MXN, and BRL are making new cycle lows, and many other EM currencies are likely to follow suit.

China reports official August PMI readings Saturday local time.  Manufacturing PMI is expected to remain steady at 49.7.  This will be the first snapshot of August activity, and further escalation of the US-China trade war is likely to keep the manufacturing sectors in both countries under pressure.  The yuan is trading at new lows for this move but we do not think policymakers will weaponize it with regards to trade tensions.