Drivers for the Week Ahead

  • US-China trade relations will likely remain in the spotlight; US Treasury holds its quarterly refunding this week
  • US data highlight will be April retail sales Friday; weekly jobless claims Thursday are expected at 2.5 mln; US inflation readings will be seen but are largely irrelevant for the markets
  • Fed Funds futures are now implying negative rates by mid-2021; there are plenty of scheduled Fed speakers this week
  • Tensions between Germany and the EC are likely to sow continued doubts about the future of Europe; on top of that, eurozone data will likely come in very weak
  • Brexit talks resume Monday so expect a lot of noisy headlines this week; UK has a busy data week
  • Australia reports April jobs data Thursday; RBNZ meets Wednesday and is expected to keep rates steady at 0.25%

The dollar is consolidating after recent gains.  After two straight down days, DXY is trying to get some traction below the 100 area.  We see potential for recent risk-on sentiment to be punctured by a variety of sources, including Brexit, EU-German tensions, and US-China tensions.  Oh, and don’t ignore another round of weak data.  The euro is still trading above $1.08 but remains heavy, while sterling is holding just above the $1.24 area.  Given the rising Brexit and EU risks, we suspect both currencies will break below these key levels.  USD/JPY is edging higher after finding support at the 106 level.  We remain constructive on the dollar but acknowledge that some further consolidation is possible.

 

AMERICAS

US-China trade relations will likely remain in the spotlight.  Despite what appeared to be cordial talks last week by phone between senior trade officials, President Trump said afterwards “Look, I’m having a very hard time with China.”  Furthermore, reports suggest Trump is still considering prohibiting US government pension funds from following any index that has a weighting for China.  This is something that has come up numerous times as US-China relations worsened.  Elsewhere, the US tightened visa rules for Chinese journalists in another sign of rising tensions.

For now, we think cooler heads will prevail, with Lighthizer and Mnuchin playing the good cops to Trump’s bad cop.  We suspect Navarro is behind the hawkish outbursts from Trump this past week, but both must understand how risky it is to take a confrontational approach with China during this extremely difficult time.  The US economy was able to survive last year’s trade war because it was strong.  Now, not so much.

The US Treasury holds its quarterly refunding this week.  It will sell $42 bln of 3-year notes Monday, $32 bln of 10-year notes Tuesday, and $22 bln of 30-year bonds Wednesday.  The total of $96 bln on offer compares to $84 bln last quarter.  Of note, the Treasury announced that it will likely start auctioning the re-booted 20-year bond on May 20 with an expected initial offering size of $20 bln.  So far, the markets have been able to absorb steadily growing issuance.  Can it digest the huge slug of issuance that’s yet to come?

April budget statement Tuesday will be a harbinger of things to come.  A deficit of -$725 bln is expected but with tax payments deferred and expenditures surging, we see upside risks to the gap.  Indeed, the increased bond issuance planned for Q2 simply reflects this new reality.  A consensus reading would take the 12-month total up to -$1.92 trln, the highest ever and easily eclipsing the previous high from early 2010 of -$1.5 trln.  The scary part is that this is just the beginning,  as we have $3 trln of spending (and counting) of fiscal stimulus coming down the pike.

The US data highlight will be April retail sales Friday.  Headline sales are expected to plunge -11.7% m/m, while ex-autos are expected to fall -8.4% m/m.  Lastly, the so-called control group used for GDP calculations is expected to fall -4.2% m/m.  A horrible April is a given and May sales will also be weak, but the question for markets is whether the tentative steps taken to reopen will translate into the start of a recovery in June.

Weekly jobless claims Thursday are expected at 2.5 mln vs. 3.169 mln last week.  If so, this would mean that around 36 mln will have become jobless over the last eight weeks, which is nearly 25% of the labor force.  The BLS said that the 14.7% unemployment rate reported last week for April would have been five percentage points higher if not for misclassification of workers impacted by the pandemic.

The regional Fed manufacturing surveys for May will start to roll out this week.  First up is the Empire survey Friday, which is expected at -60.0 vs. -78.2 in April.  Other data that day include April IP, which is expected to plunge -12.0% m/m.  March JOLTS job openings, business inventories, TIC flows, and May University of Michigan preliminary consumer sentiment will also be reported Friday.

US inflation readings will be seen but are largely irrelevant for the markets.  CPI will be reported Tuesday, with headline inflation expected to plunge to 0.4% y/y from 1.5% in March and core expected to fall to 1.7% y/y from 2.1% in March.  PPI will then be reported Wednesday, with headline inflation expected to fall -0.3% y/y vs. +0.7% in March and core expected to fall to 0.9% y/y from 1.4% in March.

Fed Funds futures are now implying negative rates by mid-2021.  We don’t want to make too much of this, as this market may be distorted due to some sort of hedging use.  From a fundamental standpoint, this really makes little sense to us.  The Fed has made it quite clear that it won’t go negative.  Of course, one should never say never but we’re really quite sure that the US won’t go negative.  In fact, we don’t think anyone else goes negative.  Why not?  Those that have gone negative regret it.  Those that haven’t see that regret plainly.  To us, negative rates really haven’t done anything except harm the banking sector and savers.

There are plenty of scheduled Fed speakers this week.  Bostic speaks Monday.  Bullard, Kashkari, Harker, Quarles, and Mester all speak that day.  Chair Powell speaks Wednesday, while Kashkari and Kaplan speak Thursday.  We suspect the negative rates issue will come up and we expect the Fed to push back against the notion.  We cannot recall one Fed policymaker that has seen negative rates as a Fed policy option.

 

EUROPE/MIDDLE EAST/AFRICA

Tensions between Germany and the European Commission are likely to sow continued doubts about the future of Europe.  President Ursula von der Leyen stressed that “The final word on EU law is always spoken in Luxembourg. Nowhere else.”  She also said that the German court ruling is now being analyzed and that an infringement process against Germany is possible, a threat she repeated on Sunday.  According to EU treaties, the ECB is independent and does not have to answer to the national courts.  If it does respond to the German request for clarification within 90 days, it will open up any EU institution to second-guessing by the national institutions.  This simply cannot stand and we suspect the EC will not back down.  That said, this uncertainty will likely weigh on the euro.

On top of that, the eurozone data will likely come in very weak.   Eurozone March IP will be reported Wednesday and is expected to fall -12.0% m/m.  We see downside risks.  Italy will report March IP Monday and is expected to plunge -20% m/m.  Last week, Germany and France reported March IP.  The former fell -9.2% m/m and the latter fell -16.2% m/m, both much worse than expected.  Eurozone reports Q1 GDP Friday and is expected to contract -3.8% q/q and -3.3% y/y.  Earlier that day, Germany reports Q1 GDP and it is expected to contract -2.3% q/q and -1.6% y/y.

Brexit talks resume Monday so expect a lot of noisy headlines this week.  Irish Deputy Prime Minister Coveney said before the weekend that the pandemic has made the timeline “virtually impossible.”  UK officials continue to say there will be no extension of the transition period beyond December 31, even whilst admitting that there has been little progress in the two rounds of talks held so far.  Here too, political uncertainty is likely to weigh on sterling and it’s a tough call whether it will do better or worse than the euro since both will be impacted negatively.

UK has a busy data week.  March and Q1 GDP, IP, construction output, and trade will all be reported Wednesday.  Q1 GDP is expected to contract -2.5% q/q and -2.1% y/y, while IP is seen contracting -5.5% m/m and construction output by -7.1% m/m.  The trade deficit is expected at -GBP2.5 bln vs. -GBP2.79 bln in February.  The Bank of England delivered a dovish hold last week and is widely expected to expand QE at its next meeting June 18, if not sooner.

 

ASIA

Japan reports March current account data Wednesday, which is expected at an adjusted JPY1.287 trln.  April machine tool orders and PPI will be reported Friday, and deflationary pressures are expected to intensify.  While it appears that USD/JPY has put in a near-term bottom near the 106, we suspect rising global risks (Brexit, EU, China) will cap any gains in this pair.

Australia reports April jobs data Thursday.  Consensus sees -550k jobs and unemployment rising to 8.3% from 5.2% in March.  Ahead of that, several measures of sentiment will be reported, including weekly ANZ consumer confidence and April NAB business conditions Tuesday followed by May Westpac consumer confidence Wednesday.  For now, it seems the RBA is on hold so that it can better gauge the impact of its unconventional policies before tweaking them.  Next policy meeting is June 2 and it’s too early to say what may happen then.

Reserve Bank of New Zealand meets Wednesday and is expected to keep rates steady at 0.25%.  Like the RBA, it is likely on hold so that it can better gauge the impact of its unconventional policies before tweaking them.  Finance Minister Robertson said that he sees no need for direct monetization of budget deficits by the central bank at this point.  He added that direct purchases would be a signal that financial system is not coping but “it actually is, and us being part of it makes sure it is strengthened.”